Why Are Homebuilders Only Now Beginning to Answer the High Demand for Housing?

Home construction in the UK has lagged behind population growth for several reasons. But determined investors and homebuilders are now moving ahead.

The UK Department for Communities & Local Government reported near the end of 2014 that housing starts for the third quarter were at 35,260, down by almost 4,000 starts from the second quarter of the year. But overall, starts have climbed since the historic low of 16,420 starts in the fourth quarter of 2008, an obvious result of the global financial crisis of that year.

Investors in development and homebuilding naturally keep tabs on these numbers, as the supply-demand mechanisms seem askew in the UK. Everyone – including property fund partners, for example, who buy and develop UK land on which homes will ultimately be built – knows that there is a great need to increase the housing supply in the country, a degree of demand that has been building for more than a decade. And yet homes sold at market prices as well as affordable and social housing lag far behind demand. An estimated one million households are thought to be waiting it out in shared flats and houses with family or friends.

The simplest answer to this conundrum is that home prices are simply too high and that younger, working households are not able to meet credit requirements. But why do natural market mechanisms and innovation not find answers to this dilemma? Economists weigh in with their thoughts along the lines of the following:

• The greatest undersupply is in London, where housing is already most dense. There simply is nowhere left to build there, as well as in other more popular, overpopulated areas.
• Greenbelt preservation, laudable in its goals, prohibits building. These are areas established almost 100 years ago when the population was less than half of what it is today.
• The Thatcher-era approach to council housing. While also laudable in turning some lower-income renters into homeowners, new social housing (as it is now called) construction has failed to keep up with younger, lower-income populations.
• Vested interests? The homeowners who are confronted with planning authority proposals to increase housing in their vicinity ardently protest new building as it could simultaneously create congestion, increased demand for finite city services and lower their own homes’ value by increasing local supply.

These are not easy forces to overcome – even when the national conversation has pushed Government policies to create solutions. Those include the Localism Act, which through the National Planning Policy Framework (NPPF) enables local planning authorities to make local decisions based on local needs. More than half of those authorities have formulated five-year growth plans, while others approach land-use changes on an ad hoc basis.

The role of the investors is critical to expanding the housing supply. UK strategic land developers – who work with financing from institutional investors and private individuals – will study where housing is needed most, then identify sites where development would be most beneficial. Where owners are willing to sell and local planning authorities will grant approvals, infrastructure is developed. Increasingly, the land is then sold to homebuilders who understand what kind of housing stock is most likely to sell and can be constructed profitably.

Investors have to consider where real estate might fit into their overall financial planning. This is why speaking with an objective, independent financial advisor is always advised in conjunction with all investment decisions.

How to Achieve Capital Growth in UK Investment Land

There are a variety of ways to earn a profit investing in UK land. It’s not all in London and it doesn't necessarily require being a landlord.

A mid-year 2014 report from the Office for National Statistics (ONS) confirmed some real estate investors’ best dreams and worst nightmares. 

The good news is that rental rates from regions outside of London and the South East – Wales, the Midlands, North East and North West in particular – are up, yielding a 6.4 per cent rise (average) since 2013. The bad news that keeps landlords awake at night is that increased prices for both undeveloped land and built properties in London and the South East, following a 20 per cent price run-up, result in lower net rental income. 

In other words, it’s more profitable to be a landlord outside of London. Which illustrates the tricky nature of achieving capital and income growth in UK real estate. But make no mistake, whether one simply trades in REITs or participates in capital growth land opportunities, there is money to be made in real estate and investing in UK land. The Census 2011 confirmed that the UK population grew at a healthy rate (a 7 per cent increase in the preceding decade) but that house building has lagged behind that by a significant amount. Approximately 200,000 new homes need to be added to the nation’s inventory per annum, but actual home construction has been less than half of that for many years. 

So with such huge demand for housing, where might an investor put his or her money? As the ONS findings illustrate, geography can make a very big difference. But the type of investment itself is likely to affect both the capital growth as well as the type of investor (i.e., the goals of the investor can vary greatly between individuals). Here are some broadly different real estate investment programmes:

• Buy, rent and wait – Whether it is farmland or an urban flat, growth will likely occur over time as you collect rent as income (or to reduce your costs of ownership). That has been the better part of the buy-in-London strategy for many, given those healthy double-digit valuation increases in recent years. But can those increases continue?

• Site assembly for resale – The strategic land investor will purchase property that is ripe for a use change – pending local planning authority approvals – then provide the infrastructural amenities (roads and utilities) necessary for homebuilding. More and more, site assembly investors then sell those properties to homebuilders, yielding a faster return on investment and allowing construction companies to determine what to build and how to make money on it. This approach allows each to assume risks they understand and are comfortable with.

• Invest in homebuilders – Per the preceding point, homebuilder stockowners or lenders can and do profit from the construction phase. 

• Real estate investment trusts (REITs) – The most liquid method for achieving capital growth gains in land is to buy shares in a REIT. Available only since 2007 in the UK, REITs are subject to general market dynamics and may be valued in ways that are unrelated to the rental or resale values of properties. 

No investor should go about taking a position in real estate and land without input from third parties. Land fund managers are skilled at outlining the risks and potential rewards of specific properties, while independent financial advisors help individuals and families identify where real estate might play a worthwhile goal in their comprehensive estate planning.

What Development Hurdles do Large Landowners Face - and What Advantages do Strategic Land Consultants Bring?

Raw land can significantly increase in value when residential use is approved. But landowners need to work with land professionals to achieve optimal value growth.

To satisfy the crush of housing needs in the UK, local planning authorities are all but required to increase the inventory of homes in their jurisdictions. About half of towns and cities lag in setting forth plans to indicate how they will do that – indication of both how much is left to be dedicated to development as well as the fact that many planners can yet be influenced on where building should take place.

The opportunity for landowners to make money is strong. But in most cases they should not assume they can go it alone – nor can they net profits from development in a clean, simple deal. The Town and Country Planning Association – noting that since the 1947 Town and Country Planning Act that landowners cannot develop land without planning permission – says that while agricultural-use property might sell for £3,000 to £10,000 per hectare, the value can increase to as much as £2 million per hectare in “areas of highest demand.”

Sounds like winning the lottery, doesn’t it? Well, not anytime soon. A planning gain supplement, referred to as a Section 106 Agreement, is essentially a tax on those who experience a significant gain in value from a land sale. The obligation this imposes, negotiated between the developer and the local planning council, is intended to cover costs from increased infrastructure (schools, roads, hospitals, sewers, etc.) driven by new residents or commercial development. Another form of this is the Community Infrastructure Levy, which is used in some jurisdictions. In any event, the large profit to be made will be diminished significantly by this obligation.

And the negotiation of these charges is merely one aspect of the development process, one that requires a skilled sense of economics and local politics. But the reason investor-developers such as property fund partners, not original landowners, more typically orchestrate the conversion of raw land to homes is due to the broad range of skills and experiences required to complete the process. Those include:

• Viability assessments, to determine the suitability of the land for development as well as the cost-return evaluations (referred to as the threshold value).
• Site assembly (plans for how it will be developed, to appease planning authorities)
• Access works (costs in road building, for example)
• Remediation (more typical of brownfield development, where toxins need to be removed)
• Abnormal groundwork (managing geological problems, such as bedrock outcroppings or floodplain remediation)
• Relocation costs and buyout of existing residents (if any)

Some developers might work with their own construction firm to build roads and utilities, as well as the homes themselves. But many now contract or sell parcels outright to homebuilders, engaging in road and utility construction only. This may diminish their profits, but also turn the land over to parties who can focus their efforts on their skill set, designing and building homes that are right for the likely buyer.

Existing landowners still can enjoy net asset gains when selling to a real asset investing group. They can work with independent property professionals to determine fair pricing.

Individual investors who themselves do not have real estate experience very often make up a portion of the investment group. They can work with as little as £10,000 to participate in a fund; such investors are strongly urged to work with an independent financial advisor to chose the investments that are appropriate for their personal wealth risk profile.

How Do the UK’s Housing Associations Work and What Do They Do to Increase the Housing Supply?

The Thatcher government shifted social housing to private non-profits a generation ago. This decentralisation has a mixed record in building new homes.

The need to answer the high demand for homes in the UK is being addressed on many fronts. Private investors and homebuilders, working through alternative investment funds, are turning unused land into homes where planning authorities allow. Institutional investors are participating to a greater degree than ever in the private rental sector. And England’s 1,500 housing associations build approximately 45,000 affordable and 5,000 private homes per year.

A policy paper, “Freeing Housing Associations: Better financing, more homes” (November 2014) from the Policy Exchange, a planning advocacy organisation, argues for a category of deregulated housing associations that would effectively enable them to double building activity to twice its current levels. The “Free Housing Associations” would be allowed to sell off expensive social properties and use the proceeds for more development. The relaxation of rules would also provide associations with greater latitude in choosing tenants and pricing, allowing them to refuse antisocial tenants and offer cheaper rents to reward good behaviour. A reported 67 per cent of housing association leaders favour this plan, in part because it could help reduce the waiting list of 1.7 million households.

Other housing association programs offer different paths to increased development. A December 2014 announcement by the U.K. Homes and Communities Agency revealed that the Government will directly fund the building and sale of 10,000 homes in Northstowe, near Cambridge. This is a new approach to increasing the country’s housing supply. The Chief Secretary to the Treasury, Danny Alexander, said that unlocking capacity in housing associations will put in motion “stalled regeneration projects” such as this one, which is on a remediated former Royal Air Force base.

Housing associations have evolved considerably since their founding in the mid-19th century and later in the Thatcher era, when social housing was transferred to private ownership and to the management by associations. Today those associations are largely generating income above their operating expenses, despite their non-profit status, according to the director of Million Homes Million Lives, a non-profit housing association. In an August 2014 editorial in The Guardian, Calum Mercer writes that housing associations have become “very profitable organisations,” with £2 billion in excess revenues largely generated on social rents, and that margins of 29 per cent were hit in 2013 and will continue rising. Mercer says that social rents are rising faster than inflation, which is what creates this windfall. He also maintains that this money is not being directed at building new homes, nor toward reducing rents, but is instead being spent on commercial activities.

Others in housing associations argue that investing in commercial properties is an essential means of generating income. The Chartered Institute of Housing warned to the contrary, that in 2014 welfare cuts and rising social housing rents spell trouble for associations’ abilities to continue building after 2015.

What this all may illustrate is that there are many ways and ideas for building in the UK. There may not be one or two or even five methods that are “the best” approach to increasing the stock of housing. Real asset funds from the private sector play a role. National homebuilders with their pools of investors are increasing their activities, as are deep-pocketed institutional investors. As should be clear, housing associations, taking different approaches, are finding ways to grow.

What’s essential is that they all do so in financially sustainable ways. For individual investors who are eager to participate, a visit with an independent financial advisor can guide him or her to identify if and how to invest in housing.

Key Tips for New Housing Sector Investors in the UK

With such pressing demand for all forms of housing, there exist many ways for individuals to invest and profit. Newbies should engage professionals to avoid pitfalls.

If hedge fund firms are investing in rent-controlled social housing, is it time for all investors to look again at residential real estate in all its many forms?

Indeed, those who put their cash in real asset funds (which develop land into residential and commercial properties) find capital gains in as few as two or three years. Those are market-rate homes, generally, that target households that are quite often already on the property ladder. But firms that include England’s Cheyne Capital Management LLP, Patron Capital, a private equity firm, and Legal & General (insurance) are seeing opportunities with social properties. Characteristic of these investments is that while rents are generally set at 80 per cent of local market rents, those rental rates are pegged to inflation.

Elsewhere in the UK, individual investors who are inclined to manage the details of being a landlord find that long-term capital gains and income are still in the offing with to-let properties.

Investors with different objectives, shorter-term capital gains, join with open-ended funds such as strategic land partnerships. These follow a process that includes several benchmarks (unlike with something such as a real estate investment trust, or REITs, which are traded on the exchanges like non-real estate equities):

• Identify smart geography – These funds are managed by experienced land-conversion specialists who first find where demand for housing is greatest. If an employer requires its workforce to travel unwieldy distances to get to work, that may be the general area in which to locate a development.
• Understand the predisposition of local planning authorities – Very often the land is zoned for other uses (agriculture, for example). While some degree of resistance to development is virtually inevitable, a smart business case can be made for how new homes and populations can add to and revitalise a community. With LPA approval, the value of the land alone escalates considerably.
  
• Proceed with infrastructure construction – The initial investors will fund development of roads and utilities and related survey work.
  
• Understand the likelihood of a Community Infrastructure Levy (CIL) – Some local authorities exercise their option to impose this charge, which is intended to offset new burdens on municipal infrastructure and services. This is more typically discussed in earlier stages of development and planning authority review.
  
• Determine if selling to homebuilders is optimal – While development overall takes raw land to the construction and sale of homes, the function often splits once the infrastructure is in place. The original investors can then see their capital gains, while homebuilders pick up the job and earn their profits by building homes that will succeed in the marketplace.
  

By and large, first-time investors in any real estate scheme will benefit from working with trusted professionals. Almost any private investor should speak with an independent financial advisor to ensure a balance of risk and reward in their portfolio.

What Strategic Land Investors Need to Know About Water and House Building in the UK

Stormwater and wastewater services are increasingly important for quality development in the British Isles. Climate change affects infrastructure decisions.

Rain is nothing new to England. But the rate at which it falls may be. To both homebuyers and homebuilders – which include urban planners and investors such as those working through real asset funds – this is becoming an increasingly critical consideration.

Why? Climate change may well be a factor in the floods that inundated parts of the UK in the winter of 2013-2014. A study out of Oxford University reported in The Guardian (April 2014) indicates that “far more frequent severe floods for residents of the crowded region, with what were once extremely rare events [are] now happening much more often than the infrastructure of the region is equipped for.”

This comes at a time when building new homes is critical to the country. More homes mean more roads, more parking lots and more roofs, factors that prevent natural absorption of rainwater. But urban planners, landscape architects, municipalities and builders are responding appropriately. They are demonstrating that communities and homes can be designed to mitigate stormwater and the damage it can cause.

For example, on both a per-home and broader community basis, techniques to channel stormwater toward natural infiltration of water to the aquifer include rain gardens and bioswales. The UK engineering firm HR Wallingford, an environmental hydraulics organisation, has done extensive work with soakaways, trenches and basins that comprise infiltration design. The firm also performs runoff and stormwater storage analyses and builds rainwater-harvesting systems that clients can use to save water for landscaping and other non-potable uses in drier time periods.

These kinds of tools break the 20th century development paradigm that most typically channelled storm water through grey infrastructure, concrete and metal pipes that ushered water away from homes and businesses to natural streams and rivers or to municipal treatment facilities. Experience shows those systems are inadequate in heavy precipitation and with growing populations.

For the development investor, such as those working through real asset fund managers, this can sometimes translate into higher development costs. And sometimes not – every site is unique and occasionally a sustainable water-management system can be cheaper than “grey infrastructure” that is based on traditional pipes. But even when the costs are greater, it can translate into more valuable property and lower property insurance costs over the longer term. Calls to the National Flood Forum (NFF) charity tripled by early 2014, a result of the flooding events of the preceding winter. It was not unusual for a homeowner to see a doubling of his or her premiums (e.g., to £2,000/year) while one small business proprietor reported an annual premium rise from £4,000 to £25,000. A smarter design for new-build communities could help avoid that.

Investors who specifically look at UK land investment opportunities for home building need to ask questions about how sustainable the development might be. They should also engage an independent financial advisor to get a better sense of where land development might fit their investment risk profile.

What is the Private Rental Sector Initiative (PRSI) and what Does it Do to Increase Housing Stock?

To-let housing was formerly the territory of small, individual investors. But larger companies are drawn to it, due in part to the growing rental sector.

The Homes & Communities Agency launched a programme in May 2009 to encourage larger investors to provide funding for a portion of the housing sector, specifically that of large-scale, market-rate rental housing. Called the Private Rental Sector Initiative (PRSI), it has been successful at attracting some insurance companies and pension funds to this form of real asset investing, providing the income flow that those kinds of investors seek.

Historically, to-let homes were the investment preferred by individuals and small companies, to whom the capital growth was the primary objective of the investment. These smaller-scale investors often absorbed operational expenses associated with market-rate rentals, whereas pension funds and other institutional investors need to generate returns that help them meet their liabilities. For them, commercial property was the more attractive draw.

But a 2014 report from Jones Lang LaSalle (JLL) shows that PRSI, otherwise known as the “build-to-let” programme, has successfully drawn £5 billion into the private rented communities sector. JLL’s head of residential investment commented on “a significant wall of money seeking UK residential assets,” and that this indicates that “wall” is in fact building walls, roofs and floors in the high-demand housing markets of the UK, inside and outside of London – including in Edinburgh and Manchester.

Why is this model succeeding now? High demand for rental properties at market rates, not social housing, is an emerging factor. A larger portion of households rent instead of owning today than before the financial crisis of 2008. Part of the PRSI initiative is in how it encourages municipalities to sell publicly owned lands for this investment, and to expedite planning procedures for getting these built.

But there remain challenges that dissuade some institutional investors. One is that the data and metrics typically employed in the commercial property sector are lacking in residential rentals. JLL also suggests rebranding this type of housing as “private rented communities,” to provide emphasis on the tenant-centric approach. The funding models too might be altered to attract long-term institutional investment money to what is still considered more risky development. “It’s innovation and friendlier planning processes”, says JLL, “which brings forward more money.”

Still, larger and individual investors see strong prospects in residential development because of the continued shortage of housing that fails to meet population growth in the UK. With shifting centres of population attracted to new employers the homes that exist are not necessarily where the jobs are. Real asset portfolio investing continues to identify UK land that can be strategically purchased, achieve planning change approvals and be developed for sale to new homeowners.

Investors looking at any part of the residential development sector need to consult with an independent financial advisor who can sort through the various options in light of the investor’s own wealth development plans.