The popularity of the Build to Rent residential asset class is growing in the UK and, with little stabilised investment stock to purchase, development of the assets is required to reach the required scale.
Managing risk in acquiring, developing and funding these new BTR assets is fundamental to their success.
Here we break down the risk areas into investment, development and design and highlight the key areas which investors and developers need to consider.
1. Investment Risk Areas
Location
Target investment in the right areas by £/sqft value: Too high a value area will not achieve the required yield. Areas with low values will not be able to generate any residual land value after development costs and profit.
Target the right micro locations by geography. The difference between a good and a poor BTR location can be a few hundred yards apart, for instance across a key road or into a different neighbourhood.
Walking the site and the routes to transport hubs, local amenities and local employment will provide an understanding of future customers’ impressions of that experience.
For example, the Packaged Living development The Castings, Piccadilly East, Manchester is well located in the heart of active regeneration just to the north of Piccadilly Station. A few hundred yards to the east is an area which is not yet coming forward and would not be as attractive.
The Castings, Piccadilly East, Manchester
Competition
Conduct a supply-and-demand analysis of each location. Some cities have seen relatively large investment volumes, whereas many are less mature. Who is the target market and what are their current rental options?
Packaged Living have a matrix of over 30 social and economic indicators relating to a particular location – from average earnings to resident demographics to transport links – which help distil the wide range of data into a ‘score’ for any location and allows a comparison of strengths and weaknesses of opportunities.
Understand the ‘comparables’. Check comparable rental values and how well let the asset is; look also at what is included in the rent. Some rents will include furniture, parking or broadband.
Consider which investors have and haven’t yet invested in a particular location. If no one else has invested, is the location convincing enough? As with any risk, the associated potential reward needs to considered along with any mitigation strategy, which includes price discovery and conservative underwriting for virgin locations.
Consider which investors have and haven’t yet invested in a particular location. If no one else has invested, is the location convincing enough?
Lot size
Get the size right by unit number. This needs to be sufficient to create a critical mass for management. However, is it too big, meaning a long absorption timescale and long-term voids? This is assessed by understanding the trends in management gross-to-net costs of different types of buildings and is continually calibrated by investors’ real-time asset-owning experiences.
Get the size right by capital amount. Investors want to deploy large amounts of capital and may seek fewer, larger transactions. However, there may be an investment cap above which they are not willing to invest and this can differ in different locations. This tends to be higher in more mature locations with more understood demand characteristics and markets.
Phasing
Can the development be phased? This is advantageous in terms of creating income more quickly, and before the total capital is fully deployed, which, in turn, can increase the Internal Rate of Return (IRR).
2. Development Risk Areas
Ground
Understand the ground conditions as best you can before you buy. The costs are always easier to predict above the ground, but there can be significant cost before that stage is reached.
Below-ground costs are wide ranging, complex and risky. They can include anything from dealing with contaminated land, diverting or upgrading local utilities, having to upgrade a foundation solution, discovering a high water-table, being in an area of historic high UXB, or coming across archaeological artefacts during the groundworks phase.
For example, Packaged Living’s The Almere, Milton Keynes, is constructed over one of the town’s main wastewater runs and required detailed engineering works and easement discussions with statutory undertakers to address.
Neighbourly
Conduct a Rights of Light assessment at an early stage. Rights of Light has become a key risk for all developers of medium-to-high density projects over last 10 years, and the implications of being on the wrong side of the discussion can be anything from a full injunction to large damages payments. There are more insurance options emerging all the time but choosing when and what to insure is a complex area.
The Almere, Milton Keynes
Planning
Do the Local Authority Officers support the scheme? This will depend on many things including whether the proposed scheme is policy compliant, is of the right scale and massing, and whether it has any impact on local heritage assets.
Will the councillors support the scheme at the planning committee? This can be influenced by a very different set of criteria, which could range from the percentage of affordable housing offered, the political will to consent a scheme against local opposition and the level of engagement that has been achieved. Sometimes local stakeholders are pleased to engage with developers, but this is not the case in all locations.
Build cost
Is the build cost right? Given this makes up the majority of the development budget, a change is the largest risk to the cost side of the financial appraisal.
Brexit, Covid-19 and other macro-economic factors have led to a perfect storm of uncertainty and inflation, which is a risk to any project. Having a mature supply chain, where repeat business and long-term relationships are the aim, will help mitigate these.
Is the scheme efficient in its design fundamentals? Good decisions made here will have a magnified effect on the overall build cost.
All stakeholders, from funders to developers to contractors to customers, have justifiably ever higher expectations and priorities in relation to sustainable living
3. Design Risk Areas
Specification
Can you create a standard specification using commonly sourced materials/products which meets budget expectations and achieves the rental tone required? If so, that consistency will positively impact the supply chain and build cost.
ESG: All stakeholders, from funders to developers to contractors to customers, have justifiably ever higher expectations and priorities in relation to sustainable living. The sector has many ways to describe the challenge and demonstrate leading practice and instilling this into a suitable brief for the design team at each design stage is an important area to address.
Building Safety: From complying with existing regulations to ensuring compliance with emerging legislation, the safety of these buildings is paramount in good design.
This is above and beyond simple CDM and requires a design team with a good ‘BTR’ track record to ensure learnings of existing buildings are being applied – for example, what is the right height of a communal balustrade?
Does this change across the country and in different rental values and demographics? Design preferences from investors, customers and local planning officers can all change in different locations. Waste chutes are a good example – favoured in the US, and by some UK investors, but not by others who have had poor management experiences with them.
Have you over-specified any element which is not actually ‘adding value’?
What the investor, developer and customer perceive as adding value can all be different and you don’t want to ‘upgrade’ in the wrong area and create a drag on performance.
Most Build to Rent buildings are about ‘renting the building’. The apartments themselves are just part of the overall offer. For example, is there more value to be gained from reallocating the spend on an expensive kitchen tap in each apartment to a better co-working space?
How much amenity space is the right balance?
Amenity space
How much amenity space is the right balance? Too little and the development will not ‘walk the walk’ of a bespoke BTR product; too much and it may actually reduce returns due to the fit-out costs of the space.
Where is the amenity space located? The ground floor usually needs active frontage so can be suitable for some, but do you add a ‘wow’ factor roof space as well? Detailed location-specific factors such as aspect, road frontage and building orientation will all contribute to this decision.
‘BBBs’: Bins Bikes Boxes
How hard does the ground floor need to work? These areas are always the most difficult to design and to get the balance right between all the competing factors/spaces.
How will the building actually be operated? Every funder/operator has a different view on how to operate the building. Can you find the right solution?