Attractive opportunities for institutional investments in the private rented sector

Investments in the private rented sector (PRS) offer an attractive solution for institutional investors who are struggling to find stable investments that offer a steady, inflation-beating income stream.

Here, Paralegal Millie Pancholi outlines how institutional investors can diversify their mixed asset portfolios and obtain long-term resilient incomes while also making a positive environmental and social impact.

The rise of the private rented sector

In recent years, the housing market has seen a shift away from the traditional homeownership model as more people opt for privately rented accommodation. The English Housing Survey for 2021 to 2022 demonstrated that 19% of households were occupied by private renters, showing a 6% growth since the early 1990s.

With average household prices reaching ten times the average household income, the PRS is predicted to grow. Rising inflation rates and the volume and quality of housing stock also impact the increasing number of people opting to rent instead of buying and owning their homes.

Tackling the housing crisis for Generation Rent

The rise of ‘Generation Rent’ contributes to the rapidly increasing demand for housing in the PRS. ‘Generation Rent’ describes adults aged between 18 and 40 years old who are being priced out of the housing market due to such a high percentage of their income being reserved for rent — in addition to high living costs, student debt and slow wage growth.

As government schemes such as the ‘Help to Buy’ scheme have come to an end there is growing demand for PRS accommodation. The previous ‘pro-ownership rhetoric’ is slowly fading as ownership becomes less desirable and achievable.

The Build to Rent and Purpose Built Student Accommodation sectors are currently popular among investors. However, the shift from direct home ownership towards holdings through asset managers presents a great opportunity for institutional investors to use their financial capability to tackle the current housing crisis by investing in the PRS.

Why does the private rental sector need investment?

Unfortunately, a significant number of homes in the PRS are not deemed fit for purpose. As explained by the English Housing Survey mentioned above, one in five privately rented homes contain Category 1 hazards including mould growth, asbestos and lead poisoning.

The subsequent health issues cause a huge financial strain on the NHS — thought to cost £340 million per year. Tragically, the extent of these poor conditions can sometimes be fatal, as seen in 2020 when two-year-old Awaab Ishak died from a respiratory condition caused by exposure to mould in his home — despite his parents repeatedly raising the issue with Rochdale Boroughwide Housing.

In June 2022, a government policy paper ‘A fairer private rented sector’ said that “the reality today is that far too many renters are living in damp, dangerous, cold homes, powerless to put things right, and with the threat of sudden eviction hanging over them”.

The current state of EPC ratings in private rents

Recent changes in legislation highlight the work that needs to be done to improve the inefficient energy performance of properties in England and Wales. Under the Minimum Energy Efficiency Standard Regulations, as of 1 April 2023 it’s unlawful to let a residential property with an EPC rating below band D.

This means that landlords have a responsibility (subject to a few exceptions) to ensure that their properties meet this standard before they let them out. Institutional investors have the power to improve this — making a positive social impact on the PRS while also receiving a steady income.

Improving the quality of housing through investment

The Department for Levelling Up, Housing and Communities estimates that the average cost to upgrade a privately rented property to an EPC rating of band C in the UK is around £7,650 per property. To provide a more substantial breakdown of the estimated costs of improving the energy efficiency of homes in the PRS:

According to EuroStat (the European Commission’s statistics organisation), roughly 75% of the buildings in the European Union are energy inefficient, yet on average less than 1% of national building stock is renovated each year. In EPC ratings obtained between April and June 2023 alone, 47.6% of properties in England and 53% of properties in Wales received a rating below band C.

With 85% of landlords operating as individuals and 82% of landlords owning less than five rental properties in 2021, it’s evident that rising interest rates along with the costs to improve energy efficiency may become an issue for these landlords.

An opportunity to make ESG-friendly investments

The funds that institutional investors could inject into the privately rented market have the potential to improve the energy efficiency of homes, comply with government plans and go one step further to significantly improve the quality of housing stock.

For example, investments could go towards electric car charging points or access to community amenities and green spaces. From this, institutional investors are able to receive stable returns while making positive steps towards combatting climate change.

There is a negative perception that investments can only result in positive change at the cost of market value returns. However, the growing noise around ESG-investing shows a strong association between commitments to ESG factors and the long-term financial performance of investments. The fact that the social impacts of investments cannot easily be valued in monetary terms should not deter institutional investors from strong and reliable investments in the PRS.

Join the rising investment in real estate

Government has a role in tackling both environmental impacts (as shown by the energy efficiency penalties) and the huge supply gap. However, the current costs estimated by the Government to retrofit the UK’s housing stock sits between £300 billion and £500 billion. According to Unison, the UK needs to build at least 340,000 homes per year to meet the demand but not enough homes are currently being built. Given the most recent budget, this target is unlikely to be hit in the near future.

Despite this, Knight Frank’s 2023 report noted that out of the 50 investors surveyed, 22% of total investment was devoted to real estate in the UK in 2022 — a significant rise from the 16% of total investment devoted in 2018.

Even a small proportion of this investment would be hugely beneficial in tackling the supply, quality and environmental and social problems in the PRS that we have discussed. Further to this, recent figures suggest that a further £4bn was injected into the market in the first six months of 2023. This shows the impact investors can make.