08 Feb 2023

Challenges around single-family rental are not without opportunity

Jonathan Long

Jonathan Long |

Much like Purpose Built Student Accommodation (PBSA) c. ten years ago and Build to Rent (BTR) c. five years ago, Single Family Residential (SFR) has begun attracting significant interest from institutional capital – Goldman Sachs, Aviva and L&G to name a few – looking to diversify their Living sector exposure.

The UK SFR market has already grown substantially in recent years. According to Savills, the number of operational SFR homes in the UK has risen 6.6x since 2016, with estimates that there could be 30,000 SFR homes in operation by 2027 and 70,000 by 20321.

An increasingly attractive sector

As a lender, it’s an increasingly attractive sector for several reasons. The residential-for-rent sector more broadly is characterised by an acute shortage of stock, while rising mortgage rates have put the prospect of homeownership even further out of reach for many people.

Focusing on the Private Rental Sector (PRS) more specifically, SFR is generally a much more affordable product than BTR for renters, which as the UK deals with a once-in-a-generation cost of living crisis, should underpin demand.

With gross to net ratios also under the microscope, exacerbated by energy price inflation, the lower operating costs in SFR – often due to less amenity space such as gyms or communal working areas, and internal infrastructure like lifts – is also appealing. The ‘stickier’ tenant base also helps with this – 60% of SFR households have children, a demographic that typically moves less often – compared with just 30% of households across the wider PRS2.

It is also a de-risked product. Most developments to date have been delivered by large, creditworthy housebuilders or through forward funding schemes, and, unlike with multifamily, schemes can be released in phases, generating earlier income whilst also delivering a more organic community feel; an important Social element.

Environmental performance is also easier to drive forward. The professionalisation of the UK rental market is an urgent requirement as 58% of homes have an EPC rating between D and G and will need to be improved by 2028 to meet Government requirements3. The granular nature of SFR compared with BTR means, for example, solar panels could be installed on the roof of each individually occupied home.

Not without challenges

Whereas BTR is an ‘urban’ product, SFR schemes tend to be in more ‘fringe’ micro locations and those regions where values are lower for open market sales, with the North West currently home to most completed stock. This requires more granular due diligence and new internal data sets when it comes to underwriting, with easy work place connectivity, proximity to good schools and access to green space all important for the viability of schemes, unlike with BTR where key amenities can be included in the development and public transport infrastructure is usually more developed.

Given the sector’s tight rental yields, arguably the biggest barrier to entry to SFR today is cost of capital: the large institutions currently active are able to acquire portfolios without leverage or using [low-cost long-term facilities]. [This resembles where the BTR sector was a few years ago, albeit a less pronounced scenario given interest rates were much lower]. Once debt becomes accretive however, we will see increased demand for a wider range of SFR funding solutions.

At Investec we have a strong track record in the Living space and SFR is a nascent sector seemingly on the same trajectory as the more mature residential for rent subsectors. It is an increasingly institutional product with strong ESG credentials that should benefit from both near-term and long-term trends, and we expect it to become a key allocation in many of our clients’ portfolios in the coming years.