Edition #3 - Red sky at night or red sky in the morning?

Welcome to the third edition of Living Capital Investor newsletter.

It’s been a busy couple of months since Edition 2 on many fronts, so what has happened since then?

Well, the obvious is last week’s ‘Genny Lec’ (as coined by KISS FM) or the UK general election to most of us. So, what does the result mean for investment into the Living markets going forward?

It’s clearly too early to tell, but given the unsurprising nature of the result, the hope is now an era of relative stability at the very least, mixed with some proper pragmatism to get us building again.

The Labour government will want to start making their mark early and yesterday the new Chancellor wasted no time in setting out her stall in relation to planning and housing promising the following:

-??????? Restoring mandatory housebuilding targets

-??????? Building 1.5m new homes by the end of their terms – including affordable and council homes

-??????? Creating a task force to accelerate stalled housing sites

-??????? Supporting local authorities with 300 additional planning officers

-??????? Reviewing planning applications previously turned down that could help the economy

-??????? Prioritising brownfield and greybelt land for development to meet housing target when needed

-??????? Reforming the planning system to deliver necessary infrastructure

Now each one of these promises needs to be properly costed and the details of new policies need to be articulated and reviewed, but at least the shopping list isn’t missing too much at this stage. There still remains a lot of ambiguity in how much of this will be achieved and it would be fair to say we are all vary of the impact of ‘taskforces’ but the new government need to start somewhere. The clock will now be ticking and the new Housing Minister, Matthew Pennycook, will have his work cut out. Here’s hoping he lasts longer than previous Conversative Housing Ministers…

During the campaign period, we all saw the comments on the plan to recruit some 300 more planning officers, which is positive in principle but with 317 local authorities in England alone this is still an increase of less than one per authority, so how these planning officers will be deployed across the country will be an incredibly important detail. ?

Many housing developments have been mothballed in the last 18 months as increased construction and borrowing costs have bitten both developer and end buyer. Without any intervention, we are facing a period of low completions in the coming few years, which may just keep prices strong in key markets if demand returns as a result of falling interest rates and a more stable economy. This will further put pressure on the Government to meet ‘affordable’ housing targets and it will be interesting to see how they can work with the housing sector to balance this dynamic.

It is worth noting there is a good depth of capital looking at all verticals across the housing sector, so the private sector does want to work with local and national government to achieve these targets, and therefore the hope is that that Labour take a collaborative, rather than combative, approach.

Moving on, the Labour manifesto was not hugely controversial with regards to higher education, merely acknowledging that there is a university funding problem to solve. Whilst lacking teeth, the acknowledgement of a university funding issue is a good start compared to the potential flame thrower policies the Conservative government were proposing.

Whilst of unpopular opinion, Labour’s relative quietness on the higher education front potentially leaves the door open to potential increases in tuition fees in the not-too-distant future. Whilst I’m not supporting nor predicting that will happen, one can see a world where this happens, and the relative demand inelasticity of higher education in theory would support a limited effect on demand for higher education if costs were to increase.

The impact on student numbers from the fee increases in 2012 would support this, but we live in different times now and students are more mobile and have more options available to them, so we need to be careful not to price them out. The significant increases in cost of living over the last few years are also much more a consideration now compared to 12 years ago, so the market may not react in a similar way.

Nonetheless, if fees were to increase, even significantly (not saying they will), the cost of a UK degree would still likely be less than the equivalent US degree, so international student demand may remain undeterred. However, it is hard to quantify where the tipping point is for domestic students, but it’s fair to say it will be at a much lower level compared to the non-EU international student market. The Government will need to understand the value drivers for UK domestic students amongst a myriad of other considerations when trying to solve this problem. ?

Away from these issues, what else should I point out?

Well, the main thing to keep a watching brief on is that a Labour government may turn the volume up on the rent control debate. Rental reform has already been kicked off by the previous Government with the Renters Reform Bill recommendations, however this was not passed before Parliament was dissolved and therefore has not passed as law.

Both sides of Parliament and the market largely saw the Bill as broadly acceptable, albeit is had been held up due to concerns that it would force landlords in the PRS to increasingly sell their properties. So, it remains a watching brief if or how the bill will be amended before being passed for debate and a vote. There is the possibility it could be shelved all together, but there’s nothing to suggest that is the case for the time being.

In relation to rent controls, research in 2023 by Colliers highlighted that the UK and Hungary are the only countries in the European region that do not have any form of rent control and debate on whether we will we see controls in the UK has been continuous over the last few years.

The question debated often among investors is whether we should outright fear rent control in its entirety or are there certain types of control that work for all? In the more recent past, I have reviewed proposals for rent controls in the form of an in-tenancy control to prevent people being forced from their homes by higher market prices and if any form of control would be acceptable in the market, it is likely to be along these lines.

Should a sensible minimum and maximum be applied, it can act as a natural smoothing effect and the nature of residential property as an investment (short contracts/more frequent turnover) means that market rental shifts are captured quickly.? A question raised in conversation recently was whether BTR / PBSA operators could use self-imposed rent controls as a central marketing point in today’s market to align themselves with their customer market and get ahead of the game??Controversial for many, but an example of how operators / investors may look to differentiate themselves in the marketplace.

There will obviously be many moving parts to this, but we’ve seen major markets across Europe embrace (hard and soft) controls and remain institutional attractive and liquid investment markets, so whilst it will change the operating / underwriting landscape, something along these lines would unlikely to be a barrier to large investment.

I’m very much scratching the surface with these sentences, but it’s worth watching to see what the Labour government do here, if anything at all. Another likely scenario is that rent control remains part of the political arsenal and rhetoric but sits in the ‘too difficult’ or ‘not important enough’ bucket for the new Government.

So, looking forward, we’ve had a predictable election result that business was largely behind, inflation has fallen back to acceptable levels in the most part, and we’re on verge of a potential start in interest rates being cut.

Does this mean the market is back and things can get moving…?

Well the transactional signals are looking more positive than they did 2-3 months ago and we’ve seen a number of PBSA and BTR transactions conclude in that time, including PGIM’s purchase of a significant portfolio of PBSA from Unite Students, HEIM’s first investment funding a McLaren Living BTR scheme in Leeds, Starlight’s forward commitment for 232 residential units from Bellway in Dartford, and Greystar’s funding of two significant PBSA sites in Manchester and Birmingham.

There are also several sizeable PBSA and BTR schemes currently under offer across the market, which should they complete later in the year and will give the market strong pricing signals as to where values are. The unsurprising general election result can no longer be used as an excuse to kick the decision making can down the road surely.

What I will say about pricing is that it is more complex than ever before. Whereas pricing used to be a yield per market applied to a net operating income, in 2024 it is a triangulation of customer sub sector (e.g. basic or premium specification), geographic market (and micro location within that town / city), ESG criteria, and fire safety accreditation. The result is quite a complex yield scenario, which needs to be supplemented by basic capital values per bed / unit comparisons.

The emergence of customer sub sectors akin to the hotel market e.g. 3* or 5* accommodation makes the capital value per bed equation also a challenge, moving the market on from a more commoditised or ‘cookie-cutter’ approach to one where investors need to understand demand and supply dynamics at a more micro level.

Nonetheless, detail aside, it does feel like people are bored of being bored. Many vendors now need to demonstrate liquidity to move forward with their business plans. Whether that is developers looking to release capital to pursue new opportunities, or funds needing to sell as part of fund winddowns or new capital raises.

This latter part is an interesting nuance of capital raising, where LP’s need a demonstration of market liquidity before they press ahead with new allocations. Give me my ￡1 back and I’ll give it straight back to you. This doesn’t render value of incumbent assets irrelevant by any means, but it forces managers to balance the past with the future. At some point we need to move on.

It does feel like this is the thawing out and positive activity is increased. Evidence of adjusted land pricing in markets is starting to come through, which means previously unviable schemes now pencil. Adjusted book valuations (particularly on land) and now starting to feed through, with owners now not shielded from the reality of the market. Portfolio book valuations for operational investments have not adjusted in certain parts of the market as rental growth and opex stability have counterbalanced yield shifts, so market liquidity remains low while weighted cost of market capital remains high.

Investors with a higher cost of capital focused on standing / operational assets have therefore had slim pickings over the last 12-18 months and the robustness of values is forcing many managers to seek lower cost funds to fulfil their strategic ambitions, so I wouldn’t be surprised to see more core plus funds enter the market towards the end of the year and heading in 2025 (eats words from Edition 2)...

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So as I mentioned right at the top of this newsletter, a lot has happened in the last few months and I haven’t even touched on UKREIIF or my discussions with a key student market stakeholders at the recent UCAS round table, therefore plenty to cover off in future editions. Nonetheless, I hope this has been a useful read and look forward to your thoughts and comments.

On a personal note, from the end of this summer my lens on the industry will be changing as I am excited to be joining Kinetic Capital to lead the business into its next phase of growth and positioning the platform as a leading debt provider across the European living sector. I am immensely proud of what we've achieved at Colliers and I leave behind a brilliant team , who I look forward to working close with in my new role.

This newsletter will continue, and I’ll be trialling some new ideas to ensure it remains informative and relevant to all that read.

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