Investment boom for UK multifamily sector
The private rented sector (PRS) in the UK has grown significantly in the last decade and the multifamily sector in particular has attracted substantial investment from new overseas investors, with Greystar, Atlas and Courtland each gaining a foothold in the UK market.
According to the British Property Federation (BPF), there are currently over 150,000 multifamily units completed, under construction or with planning permission in the UK and nearly 75,000 of these units are in London, showing the sector's growing popularity which is only set to increase.
Coronavirus has forced many countries in the world into a state of lockdown – and the UK is no exception. This has caused many people to reflect on their current living and working arrangements, as never has it been more important to have a flexible place to live, work and play.
In general rented homes in the UK typically consist of unsold development units or owner-occupied homes converted into buy-to-rent. Whilst some are good, there is an element of sub-standard accommodation with tenants receiving poor service and little long-term security. In comparison, multifamily developments consist of properties designed and built specifically for renting. This means they are usually of a high quality, in good locations and often offering onsite facilities — such as fast and reliable broadband, gyms, games rooms, communal work and outdoor spaces, concierge services and parking — which are very attractive to UK renters seeking more flexible places to live and work.
This need for high quality rental properties will be further accelerated by the fact the fundamentals underpinning demand will not have changed when we emerge from the coronavirus pandemic. There is still a chronic shortage of housing in the UK — a recent Royal Bank of Scotland strategy paper forecast that renters will outnumber home owners by 2029 — this, together with a likely economic downturn stifling wage growth, will make it difficult for people to save and overcome hurdles in the mortgage market, giving the multifamily sector a real opportunity for growth in the UK.
UK vs US multifamily
The UK multifamily sector is relatively young compared to the more mature US multifamily sector. As a result there are a number of unique differences that investors will need to consider as part of their investment strategy. Brief examples of these are set out below.
Valuation and land prices
Multifamily operates a different investment model to build to sell, as it relies on income through rent over a number of years, rather than an upfront return on sales. In some circumstances multifamily may not be able to compete for land on an equal footing with build to sell, as it may generate lower initial land values. This can be particularly challenging in the UK, especially in London and the South East where land prices are high. Investors will need to consider the location of projects carefully; the viability of projects in UK regional cities may be easier.
Financing
There are numerous ways to finance a real estate development. However, investors in UK multifamily increasingly use a forward funding arrangement, which is relatively new to the residential sector. An investor will commit to purchasing the development site and to fund the development costs; a developer will then build the development for a guaranteed fixed price; and once the foundations are completed the development site will then be sold to the investor; and the developer will be employed to deliver the development project.
The advantage of this type of arrangement is that it gives the investor early control of the development site but protects the investors exposure to development risk by agreeing a guaranteed fixed price with the developer to deliver the project. This is often backed up with a parent company guarantee or provisions for liquidated damages if the development is not completed by a specific target date. For the investor, this means if the development is not built, or the developer is in default, there will be some form of return. This type of arrangement can also be efficient from a tax perspective, as if structured correctly, Stamp Duty Land Tax (SDLT) will only be payable on the price paid for the land rather than the total cost of the development.
Tax
An acquisition of land in the UK may be subject to Value Added Tax (VAT) at the rate of 20%. However, if land is acquired once a development has reached a certain stage (as would often be the case for the type of forward funding arrangement described above), the applicable rate of VAT may be reduced to 0%. In certain circumstances, a sale of UK land may also be exempt from VAT. An investor also may incur VAT on the development costs at rates of up to 20%. Depending on the intended rental model, VAT incurred on the acquisition and/or any development costs may represent an absolute cost to the investor or the investor may be entitled to recover some or all of this VAT cost from the UK tax authorities.
The investor will be required to pay SDLT on the acquisition price for the land (including VAT if applicable). Where the investor acquires the land and separately pays a developer to build the development, the development costs should not normally be included in the price of the land for SDLT purposes.
The UK has a special tax regime for payments to construction contractors such as developers, known as the construction industry scheme. The investor will be required to verify the developer's registration status under this scheme and may then be required to make deductions from payments to the developer and account for the amounts deducted to the UK tax authorities.
Depending on the structure used, the investor may be subject to UK corporation tax on any rent received from the development and on any gain realised on an eventual sale of the development.
Planning
Local planning authorities in England and Wales may grant planning commission permits and approvals subject to certain planning obligations to make the proposed development project acceptable. An example of this is to require a certain number of affordable housing units to be built (i.e. units with rent payable at less than local market rents), or to make contributions to matters such as education, public space or healthcare. In addition, local authorities have the right to require Community Infrastructure Levy (CIL) payments to be made, which are calculated with reference to floorspace. Larger developments can attract CIL liabilities in the millions of pounds. Investors will need to factor in these additional development and impact fees and costs to their investment strategies.
Title
A potential development site can be affected by various adverse matters which will need to be identified at an early stage to ensure they do not affect or delay the development project. An example of this for multifamily developments in the UK are rights of light. Rights of light are valuable as they give owners of the right certainty that natural light will continue to be enjoyed by a property, increasing its value, utility and amenity. If a window overlooking a potential development site has a right of light then the development may be restricted, such as preventing the building being built as high (or at all) because that would block or reduce the light passing through the window or where the development has taken place the building (or part) may be demolished. Investors will need to ensure they carry out comprehensive due diligence of the development site.
Construction
It is important investors protect themselves if something were to go wrong with the construction of the development. For this reason in the UK, in addition to the contracts an investor may enter into with the main contractor and professional consultants, there will usually be arrangements for collateral warranties. These warranties provide a legal remedy to the investor against key members of the project team in the event of a defect in design or workmanship (where otherwise there would be no remedy). They may also include a right for the investor to step-in and take over the development if there has been a serious breach which is not capable of being remedied. In bigger projects it is also not uncommon for investors to purchase Latent Defects Insurance which provides cover for twelve years from the original construction date for defects including, in some cases, loss of rent.
Property management and maintenance
It is essential a multifamily development is properly managed and maintained to protect its long-term value. Investors will therefore need to factor these costs into their budget to ensure their development project is workable. In the UK, it is common for investors to set up their own management companies to be more efficient and save on costs.
Regulation
The UK's rental sector has a significant number of regulations that must be complied with by private landlords ranging from energy efficiency obligations to checking a tenant's immigration status to complying with measures in relation to gas, electrical and fire safety. In addition, new regulations on tall building safety have been introduced following the London Grenfell Tower fire in 2017.
Political measures
The current UK government intends to modernise the rental sector and recently announced that it would end so-called "no fault" evictions so that tenants cannot be evicted from their homes without good reason, as part of wider proposals to review the long-term security of tenure regime for residential tenants. These are currently the subject of political debate and much will rest on the detail of the proposed changes which are not yet clear.
What next?
It is clear multifamily is becoming an established sector in the UK rental market and with the coronavirus pandemic creating a period of economic uncertainty, the mortgage market in flux and people looking to change their working and personal lives, multifamily is only going to gain more interest and investment.
If you have any queries relating to the information provided in this article, please contact Martin Wright, Caroline Humble or Philippa Thomas.
