Revealed: smaller institutional investors locked out of investing into UK residential

13 July 2020 | Investment

A new report has found that the UK’s residential market is missing out on billions of pounds of potential investment from smaller institutional investors because of a lack of suitable investable vehicles.

The research, conducted by Cambridge Research and Investment Consultants (CamRIC) on behalf of investment manager Seven Dials Financial, examined the UK residential market to determine the choice of investment vehicles available to the smaller investor investing under £2 million.

The headline finding of the report is that residential remains almost as impenetrable to the small or private investor as it was a decade ago. While smaller institutional investors such as pension funds for local authorities are being locked out of the UK residential market, the report argues their larger cousins are able to invest with abandon into sectors which are defensive in nature such as Build to Rent (BTR).

Although there is a commonly held view that UK residential is maturing as a real estate sector, rapidly becoming a standard part of an institutional property portfolio (with the likes of BTR and purpose-built student accommodation increasingly popular among corporate investors), it’s a different story for smaller institutional investors, where the conventional way to allocate funds into UK housing is through a buy-to-let house or flat.

Given the uncertain economic conditions created by Covid-19, many institutional investors – both large and small – will be looking to allocate their assets towards safe havens, of which UK residential is one.

Residential property has performed better than most other asset classes in recent decades, with strong house price growth in real terms, estimated at 2.6% between 1975 and 2019. Meanwhile, residential rents have inflation-matching characteristics – with rents having increased by 3.9% per annum compared with Consumer Price Index (CPI) growth of 2.6% in the period 1988-2019, the report finds.

In addition, the report said that encouraging more institutional investors will be vital for the growth of the UK private rented sector, especially when recent stamp duty tax changes have made it less feasible for the individual buy-to-let investor. In April 2016, the government introduced an extra 3% stamp duty surcharge on second and buy-to-let homes to discourage the rapid growth of the sector and improve the chances of first-time buyers getting on the property ladder. 

According to the 2019 Investment Property Forum (IPF) report on the ‘Size and Structure of the UK Property Market’, institutions currently only account for £35 billion of the over £1 trillion PRS market.

Mickola Wilson, director at Seven Dials Financial, said: “Much has been made of growing institutional investment into UK residential, but by effectively barring the smaller investor from being able to allocate their funds efficiently, the asset class risks losing out on significant amounts of capital that will be seeking a safe haven against the backdrop of the economic crisis caused by the pandemic.” 

She added: “Our findings show that aside from investing directly into buy-to-let, REITs remain the best bet, though the limited number of UK residential-focused REITs and the fact that these vehicles are vulnerable to stock market fluctuations means that for many smaller investors these may not prove suitable vehicles.”

Wilson said there are a number of new investment vehicles in the pipeline that may allow a greater amount of smaller institutional investors to enter the market, and added that ‘we look forward to seeing these emerge as UK residential is a strong asset class that will prove attractive to a variety of investors’. 

She concluded: “There should now be concerted efforts to open this asset class up to a wider array of institutional investors, especially as today’s market conditions mean many managers will be looking to allocate their funds into safe havens.”

A lack of ‘investable’ choices

The research by Seven Dials and CamRIC analysed the ‘investable’ choices for prospective investors in the residential property sector.

In the pure residential market (excluding student housing), they took a sample of 30 vehicles which are currently open for investment and analysed them against their own investment criteria for a portfolio strategy for a smaller investor. 

It found that the choice of investable vehicles is limited, including PRS-focused REITs, Retail Property Funds, Institutional Property Funds (which are rarely suitable for smaller investors as the minimum investments are often significant, e.g. over £5 million), and other investment funds typically run by specialist managers. These latter funds are illiquid, but in general, investors are compensated with higher returns. 

The report showed that for the savvy investor, or their advisers, the best move is to look to invest in the residential market via some form of collective investment, so as to ‘diversify their risk’ and ‘benefit from the use of specialist managers to source and manage the property’. 

However, the research also warns that it is a mistake to think that the market is sufficiently mature to offer the smaller investor much choice and that, in fact, even for larger institutional investors the choice is surprisingly limited, which is why many funds such as Legal & General have created their own residential portfolios.

<!–

–> This post has originally been featured in Property Investor Today.