Jonathon Ivory is managing director of Atlas Residential, a US-owned company that wants to build 10,000 build-to-rent units in the UK, with three sites already under construction. He explains the risks and challenges involved in blazing a trail in this burgeoning sector of the market.
You are being quite brave in embarking on a drive to build new multi-unit blocks for residential rental, I say, given how dormant the build-to-rent market in the UK has been for decades. (I mean brave in the sense that a civil servant like Sir Humphrey in Yes Minister would use the term – as in career-threatening if wrong.) But Ivory, a former real estate investment banker, a profession that rarely takes a backward step, is having none of that.
“Can I pick up on your point about being brave? We don’t think that’s necessarily the case. People have been renting, whether it’s houses or apartments, since the country has been building them. It’s just that the ownership of those apartments hasn’t been in what we call institutional hands really since the 70s. All we’re really doing is reintroducing a form of ownership that previously existed and overlaying on top of that a level of professionalism and customer service that we think residents, whether they’re British, North American or wherever, will react positively to. Everyone likes being looked after and treated well. I wouldn’t say we were disrupting or reinventing the wheel. We’re simply doing something that Brits have been used to for decades and we’re just doing it a little bit better. There’s no controversy in that.”
It is true, I concede, that you only have to look around the most fashionable parts of London to see scores of big mansion blocks that were built with institutional money for long term rental – but that was a long time ago, and the world and the regulatory framework was very different.
This concept has been around for a very, very long time. All we’re really doing is reintroducing that theme
“Exactly,” Ivory responds. “Essentially, the Victorians invented our business model. They didn’t use the word ‘institutions’ back then, but large landlords would wholly own and manage blocks before they were broken up on a long leasehold or freehold basis. So the concept has been around for a very, very long time. All we’re really doing is reintroducing that theme. People rent in this country. The rental inventory is in excess of £1.2 trillion in terms of appraised real estate value. So the asset class is vast and has existed for an extremely long time. So, as I said, we’re just introducing things like customer service and professionalism in a way that the UK consumer hasn’t really benefitted from for 30 or 40 years now.”
But isn’t that the point, I say. It’s beyond the memory of a lot of people that this was a model of how people used to live. Ivory agrees. “Right. And that skill set has left the industry. So, if you were a commercial fund manager for the Prudential in the 1970s, then you would’ve had, most likely, a residential portfolio within your remit. But obviously, once those portfolios were broken up and sold off, those skills were lost, to retail and office and things like that. I suppose people are having to relearn a trade, if you will.”
So let’s be clear, I say, about what it is exactly you are doing. You already have three projects underway in Southampton, Birmingham and Salford, with nearly 1,000 flats planned or under construction? “That’s correct. As a single landlord, we are building at scale and scale allows us to provide the kind of economies and efficiencies that we need to deliver the customer service that I was talking about. We have three sites presently in construction. One is now operational. It’s a little over 850 units with an appraised value north of £160 million. We will operate each building with an on site community manage, plus leasing and maintenance staff also on site.”
“The closest analogy I could draw for you would probably be that of a hotel, but without the nightly changeovers and the overheads of maids and food and beverage and things like that. It’s very much taking inspiration from the hospitality industry in terms of customer service and amenity. So we’ll have a gym or a fitness room and a residents’ club lounge or a cinema or something like that – whatever’s appropriate to that local demographic. And it will be run with a relatively small and efficient team on site who can deliver those services at the point of need, so that residents will know who their manager is, they will have a relationship with the staff there, they will be able to organise events through them and we’ll provide a forum for that, whether it be a jogging club or dinner parties or anything like that. We will also make spaces available to them to host events and birthdays.”
“More importantly, the upkeep and maintenance of the fabric of the building will be undertaken by an on-site team, which is really something you don’t see in our competition, which is the buy-to-let universe – Mom and Pop style, as Americans call it, pepper-potted apartments where the landlord is unable to provide the same level of service and management, simply due to the lack of infrastructure and scale that we’re afforded by virtue of the large schemes that we’re doing.”
So, if you are a tenant in one of the properties, do you pay a service charge on top of the rent? “No, we don’t charge a service charge. There will be a base rental payment. Typically, in an Atlas building, things like access to the fitness room and the club lounge and so on would all be free. What we will do is we will offer additional services on top of simply the apartment. We call that ‘other income’. It’s a separate line item or items in our operating cash flow. That is a very varied list. Again, it’s dependent on what that local demographic wants. It’s a menu of services that we will provide.”
“It might be dog walking, dry cleaning or having your room cleaned. Again, it’s a long list that is specific to each property and each resident demographic. Residents can choose to use those services or they can choose not to. If all they want to do is just stay in their apartment and pay their rent and pay the utilities, then that’s absolutely fine. If they choose to take advantage of the additional services that we’ve curated at each building, then they’re able to do so too.”
“Going back to the scale concept, essentially we’re a gatekeeper to a large community of residents. That gives us buying power. So, we can do things like go into the market and negotiate a broadband deal on behalf of our residents and then provide that service at a reduced cost to them that they would otherwise not be able to obtain as a single retail user. That’s a large part of our business and what we do is provide auxiliary services to our residents.”
This is about customer service and what the resident wants
As a tenant, what sort of lease am I going to be offered? What kind of terms am I going to be taking the place on? “We’re flexible with regard to leases. We will primarily offer twelve-month ASTs [assured shorthold tenancies] because that’s what most people are familiar with, but we will offer up to three years if the resident is interested in something of that length. And that’s something that the government is very keen to see us and our peers offer to increase that security of tenure. But even that in itself is an education piece because most landlords don’t offer those kinds of leases. We have found that residents are cautious and will maybe sign a twelve month AST initially and then when they come to re-lease, will realise, ‘actually, I’ve had a great time and experience in this community and so I am looking to stay longer and will sign that longer lease’. But again, we’re flexible. This is about customer service and what the resident wants. So, to the extent that we can provide that, we will.”
And what if I at one point say, ‘I want to buy this place’? What happens then? “The answer is, of course, no. What we don’t do or are very unlikely to do is sell off individual apartments. We think that will compromise the value of the asset. So, when these buildings trade, and I speak now to our US experience, they typically trade to other institutions as a whole block, either as a single community or it might be part of a wider portfolio. That’s typically where the trading occurs.”
Within your three developments, what is the mix between one, two and three bed flats? “It depends on the site. Real estate, as you’ll understand, is local. So, the unit mix, the ratio of ones to twos, the size of the units has been, to an extent, curated based on what we believe the local resident demographic profile is now, but also what will be in the future. So, there’s an element of futureproofing in our design and that informs our thinking when we come to these projects. There is no one-size-fits-all.”
Let’s take Southampton, I say, your first development. Are your flats targeted at young professionals or families? What is the demographic? For the most part, says Ivory, they are the young professional or the millennial renter, as they’re often called, with ages between early 20s and mid-30s. “That is certainly true of our Southampton project which is almost 80% leased, although we only opened the doors four weeks ago. When I speak to the leasing staff down there, the typical profile is certainly that 20s to early 30s young professional, either single or sharer.”
“But what we’ve learned – and this is informed by our US experience where we’ve been owning and managing these apartment communities for nearly 30 years – is that no amount of demographic analysis, market reports or forward planning and thinking can tell you exactly who that resident is going to be on the day you open the doors. You’re just as likely to get the retired couple from Devon who’ve decided to move back into the city because they’re downsizing, and they’ve freed up the equity in their family home, or the divorced 55-year-old dad who needs a place to stay.”
Buildings change, cities change, areas change, demographics change and fashion changes
“So when we design our schemes, we try to make them as flexible as possible and as appealing to as wide a demographic as possible. I think the error some operators take is they pursue, too doggedly or narrowly, a single type of resident. Buildings change, cities change, areas change, demographics change and fashion changes. Things which were fashionable or popular when they were conceived may no longer be so in five years’ time. So we try to give some thought to the design and flexibility of our space to appeal to the widest audience possible. Because the reality is, when you open those doors, you genuinely don’t know who’s going to walk through them and lease your properties. You start out with an idea and if you’re lucky, that business plan holds true. But it’s important to remain flexible.”
These people who have come to you, I say, is it because you’re offering them exactly what they want, or is it because they are people who would rather own their own house, but just happen to have no alternative? “I think that’s a great question. Fundamentally – and remember, we are in the apartment lettings business – we believe that everybody wants to own. Whether you’re North American, whether you’re British, whether you believe an Englishman’s home is his castle or you subscribe to the American dream of homeownership, everybody wants to own. It’s just that that is either not appropriate for that stage in your life, maybe because you want job mobility and flexibility and things like that, and it’s more of a lifestyle choice, or it is simply not an economic reality. Maybe you are unable to save up for the deposit because the capital value is so high.”
“In answer to your question, people are coming to our buildings and renting our apartments because there is a fundamental supply-demand imbalance in the UK. There is not enough housing and they are looking for shelter. We like to think that once they get there, the lightbulb goes on and they go, ‘ah, this is different. I’m not dealing with a lettings agent, I’m dealing directly with the landlord. I understand that if something breaks, that landlord will fix it within twenty-four hours. This does not have the look and feel of my last apartment which may have been owned by an absentee landlord’, or something like that. So I think it’s about education. Winning hearts and minds takes time. That doesn’t happen overnight. But fundamentally, people need places to live and if you get the basics right, which is being in the right location, being at a price-point that’s affordable, and looking after that building, you will have a stabilised, popular building.”
Is the business model of Atlas Residential to sell on the blocks it is building to somebody else? “We haven’t answered that question yet. It’s very likely that we will certainly sell certain assets to other institutional or investors seeking a stabilised yield. That’s highly likely. But again, based on our US experience, we’re no stranger to aggregating a portfolio so that we can enjoy that stable income. One of the reasons why we like the asset class is there are so many options available to you once you reach that kind of scale. We might refinance, we might do an IPO, we might sell off portfolios or we might sell the entire portfolio. The answer is I don’t know. We haven’t got to that stage yet. The business plan now is to aggregate that portfolio so that we can create that kind of optionality.”
One of the big issues facing the build-to-rent sector is that the yields you can get are quite low. To make your numbers work, surely you have to realise some capital value at a point within the foreseeable future? “I disagree with that. Fundamentally, we think that these apartments or homes – it doesn’t have to be apartments, the model works in the single family home asset class as well – are more valuable with people in them paying rent than they are vacant for sale. And that, to answer your original question, is probably where this becomes quite pioneering. Because that recalibration, or shifting of the mindset, to suggest that actually the income is more valuable than the vacant possession value is a fundamental sea change in how these assets are perceived. That, to your point, is where we perhaps are brave and are pushing this business in new directions.”
What kind of yield then is Atlas looking to realise from its pioneering projects? Suppose you filled your property in Southampton, with 100% occupancy, what sort of yield would you be getting? “Right now, we are investing only in the regions, outside London, as I mentioned, in places like Birmingham and Manchester. We use leverage too so, using a levered return, we fully expect to be getting 7.5% cash-on-cash yields post-tax once these assets are stabilised. That’s a really important point because I don’t know where anyone is getting a return that is better than that on a risk-adjusted basis. Remember, we’re talking about a very defensive, counter-cyclical asset class that fundamentally is providing a basic human requirement, housing. We are delivering it into a market that is fundamentally undersupplied. As long as we’re in the right location and we manage these buildings correctly, we think that is a great rate of return for such a risk-adjusted asset class.”
That kind of yield certainly looks more interesting at a time when the traditional long lease upward only office model, for example, is on the way out. “Well, as you’ve seen via all the disruption that’s happening in that serviced office space, those 25 year leases are becoming extremely rare now. And in terms of the length of those leases, whilst they are clearly not the same as a residential AST, they are taking on similar kinds of characteristics in terms of multi-let, reduction in lease length and things like that, and the granularity of those underlying leases too.”
An obvious question then, I say, is if build-to-rent is such an attractive thing, why aren’t more people doing it? “I think it takes time. When you are disrupting or creating any new asset class – and obviously, I use the word ‘new’ in the context of our earlier conversation about there being a build-to-rent industry as far ago as the 1970s – there is a lack of understanding and education. In fact, from a low base, the sector has grown extremely quickly. I think the latest statistics indicate there is something approaching 100,000 build-to-rent properties either built, in construction or in the planning pipeline. And that’s, for the most part, all come through in the last five years. I think that the industry has moved pretty quickly considering its low base.”
When you are disrupting or creating any new asset class, there is a lack of understanding and education
“I think the reticence or sniffiness from the institutional commercial world in the way it regarded residential, that mind shift has occurred in a comparatively short period of time. I can remember when I started in this business, specifically build-to-rent, I would spend the first 20 minutes of every meeting trying to explain to people what I did for a living. I’m fortunate enough I don’t have to do that now because it’s such an – well, I won’t necessarily say accepted – an increasingly well-known asset class.”
A few years ago a government sponsored review, led by Sir Adrian Montague, looked into the obstacles to build-to-rent development and found several, I say. Given those obstacles, is it practical to think that build-to-rent can become a significant force in this country’s property market? “I absolutely do, yes,” Ivory says. “Is it going to single-handedly solve the housing crisis in the UK? No. Is it a viable part of a multi-tenure solution to that, that includes social housing, student accommodation, build-to-rent, build-to-sell, assisted living? Yes, absolutely. Will it play an important role in all of that? I believe that it increasingly will, yes.”
“We’ve seen that already in the growth of the rental inventory, which is growing at the expense of home ownership and has done for the last decade. We don’t see that trend reversing any time soon. I can’t think of how that would happen short of the government getting directly into the housebuilding business and building homes and providing cheap loans, which I’m not sure it’s inclined to do. We think whilst capital values won’t continue on the tear that they have been on over the last twenty years, they still remain historically high relative to earnings. And set against a growing population, despite the Brexit headwinds, we are still year-on-year adding to our population. All of that really means that we will continue to create what we call renters of necessity, meaning people who may want to own, they don’t have the ability to do so. That creates more customers, more residents for this particular product. We think it’s here to stay.”
At the moment, a lot of the rented sector is in the hands of buy-to-let landlords, who had a lot of tax advantages for a number of years but which are now being taken away. Does Ivory see what his firm is doing supplanting buy-to-let? “I think buy to let is declining, but from a very high starting point. There’s nothing wrong with individuals owning properties for rent, whether it is for income or as part of their retirement investment portfolio. I think that will always remain a significant part of the UK’s housing stock. But remember, the government has essentially outsourced homebuilding to the private sector. I know everyone likes to complain about their landlord, but we should be thanking them for picking up that slack and providing homes for people to live in.”
There are plenty of good buy-to-let landlords, but also many who charge too much for poorly maintained property, I say. Ivory concedes that point. “Is the quality [of buy-to-let housing] good enough? The answer to that is no. Buy-to-let will always have a place, but it will become less prevalent as institutional capital becomes the de facto or default funding solution or take out for housebuilders or residential developers. I think it’s going to be an increasing asset class, particularly at the expense of buy-to-let.”
Buy-to-let will always have a place, but it will become less prevalent
What I’m a little confused about, I say, is whether or not the government is helping the development of build-to-rent or not. “You and I both!” says Ivory. The Montague Report, the Build-to-Rent Fund and the Debt Guarantee Schemes are all initiatives that have helped the sector develop from its embryonic state five years ago. But, he says, the Cameron administration was less supportive of build-to-rent and seemingly more wedded to home ownership. Mrs May’s government seems to be more aware of the role that, build-to-rent can play in the housing solution. “Certainly, the mood music that we hear from DCLG [the Department of Communities and Local Government] seems to be supportive of our sector and some of the legislation coming out of Whitehall now certainly points in our direction. We’re pleased with the way things are going.”
Is there any one thing on your wish list that they could do to really help transform particularly what you’re trying to do? “I don’t like to beat the drum for government interference. I tend to think markets work best when they’re left alone. But that said, clearly reforming the planning situation and being able to streamline what historically has been a very sclerotic process would benefit not just build-to-rent, but build-to-sell real estate housebuilding too. Looking at areas of the Green Belt, and not simply assuming that it’s all lush fields and woodland, and taking an intelligent approach to which parts of it can and can’t be developed, would be helpful.”
“As I say, short of the government getting in to the housebuilding business, I don’t know how we deliver the number of homes to meet the year on year shortfall. A lot of people would say the removal of the SDLT surcharge would have an impact on our business. And it would. But I think on its own, it’s not the reason why a deal does or doesn’t get done. It’s more nuanced than that. There are a variety of factors with each transaction, because ultimately real estate is local.”
What is the biggest obstacle that is holding back build-to-rent? “Our biggest frustration right now is we think that there is an asset bubble occurring within our sector, partly because of the perceived popularity, or weight of capital looking to enter it, that is arguably uncorrelated with the true values on the ground. That’s fuelling, we think, some unreasonable aspirations and arguably slowing down the delivery of these assets.”
What you’re saying is that people want too much money for their sites? Is that basically what it is? “In a nutshell, yes. That sounds like an investor grumbling about the price of assets, but you see this in the 11th hour of every real estate cycle where yields are compressed and asset bubbles are forming. I think that the popularity of build-to-rent has gained such a momentum now that in some areas it has got ahead of itself and prices are uncorrelated to the true value on the ground. There is a difference between perception and reality, if you will. That can have a damaging effect to the delivery.”
“Obviously, if there’s stand-off between buyer and seller, if that bid-ask spread is too wide, then that deal won’t get done and those assets won’t get delivered. Or at least, not in this cycle. And that’s a shame. I’m not tarring everyone with the same brush. We read a lot about the wall of money chasing this sector. And whilst it’s true that institutions are certainly interested, I would leave it at that. There is interest, there is activity, but there isn’t as much interest and/or activity as I think everyone, or some commentators, would have us believe.”
In other words, it’s not just recalcitrant local authorities or planners holding up the whole process by insisting on lots of affordable housing that no-one can make work? “No, and I’m not focusing on the affordable housing challenge, which in and of itself certainly creates issues with regard to viability. But that’s an old story. That’s not just a build-to-rent dilemma. That has been true of homes for sale as well. I’m simply suggesting that as an industry as a whole, I think we’ve got a little bit too ahead of ourselves in terms of where values are. I think there’s been a yield shift that is uncorrelated with the underlying true value of these assets.”
As an industry, we’ve got a little bit too ahead of ourselves in terms of where values are
It seems logical to ask therefore what impact a rise in interest rates might have on the pace of new development. Ivory says it is not a great concern. “One of the reasons we like this asset class is because it does provide a good inflationary hedge. Typically when interest rates are rising, that usually means the economy is doing better, most likely there’s wage inflation coming through and that then typically feeds back in to increased rents. They are in lock step with those rising interest rates. It’s not a perfect mechanism but it does provide you with a decent amount of insulation and that’s why investors like it, because it is inflationary. It’s a good hedge against inflation.”
“If we are suggesting that the rental apartment business is a beneficiary at the expense of home ownership, which essentially underpins part of our business model, then if rising interest rates create affordability issues or problems with people servicing that debt, then yes, the apartment business will benefit from that. It’s a very defensive, counter-cyclical asset class. So, it performs well in those kinds of situations.”
Turning to the wider political picture, I conclude, with popular concerns about inequality, and politicians flirting with the idea of rent controls once more, is there not a risk of a political backlash that impacts build-to-rent?
“I don’t think there’s a political risk to what we’re doing. Why? Well, what are we doing? We are providing a basic human requirement, which is shelter, but we’re doing it in a way and at a level of professionalism that the UK consumer has not previously benefited from. I don’t accept that our business model is in any way controversial or unhelpful to the UK plc or UK real estate. Remember, we’re providing apartments for rent. People have been doing that for a very long time. We’re just doing it better than previously.”
We’re providing apartments for rent. People have been doing that for a very long time. We’re just doing it better than previously
“As for rent controls, I think the one thing you will find economists of all political stripes agreeing on is that wherever we have seen rent control throughout the globe, it has not done two things. It has not delivered more housing and not increased the quality of that housing. That’s simply because if you tell an investor like us what they can and can’t charge their residents, then that investor will choose to invest elsewhere. Essentially, it’s a cap on profits. The third and final perverse effect which is to increase rents, because there is less supply coming through. So, we are clearly not pro rent control, and I think you’d struggle to find any right-thinking people in the UK who think that the solution to delivering more homes in the UK is to control rent and limit the operating ability of companies like ours.”
That is true at the aggregate market level, I say, but there are still, of course, a lot of people who are suffering at the hands of under-capitalised or absent landlords and living in sub-standard rental conditions – that is where the political impetus for intervention comes from. “Yes, and the solution to that is to build more homes where they are needed and raise the quality of them. Vis-à-vis my point about deregulating planning, perhaps we need more of a top-down governmental approach on where homes are needed. But top-down suppression of market rents has the opposite effect of what the desired intention is. It’s very misguided. What frustrates me is the people that espouse it probably know this, but it’s nakedly political and they think that it makes good copy in newspapers for their core base. It’s very cynical, and that’s putting it politely. It’s cheap political capital.”
It is conspicuous is you’re not doing anything in London at the moment. London is unbelievably expensive. It’s where everybody wants to live and it’s overcrowded. Do you see any chance of you ever building something in London? “I do, yes. We definitely will. We have, as a business, tried to predict the flow of capital and to an extent read the mood music of the direction of travel. So, for example, we were the first to do an institutionally backed PRS scheme in Southampton. We were the first to do a build-to-rent scheme in Birmingham. We were the first to do one in Media City, Salford. And really, we’re just trying to stay ahead of the pack by doing those transactions. To my point about yield compression, what we don’t do is buy once those yields have compressed, because at the end of the day, we are yield driven.”
So, you’re saying you won’t do any more if the price isn’t right? “Correct, yes. That’s just the fact of cost of capital. So, we are in the value creation business. We are looking at areas throughout the UK that demonstrate all of the ingredients that we need, be they positive job and population growth, good transportation, things like that, and then looking to invest in those locations and trying to stay ahead of the pack or the curve so that there are opportunities for that value creation. Because often, by the time people have realised that’s a good place to be investing, then the ability or that margin for profit gets reduced. And that’s just economics 101.”
In another interview you have given, you said there were two main barriers to advancing. One was about the yield perceptions, which we’ve talked about, and the other was the high cost of construction. How serious is that issue? Have you used UK architects and UK construction firms?
“Yes, we have. It’s public knowledge though that Bouygues, who happen to be a French contractor but with UK offices, are building two of our projects. Construction cost inflation is a challenge that is throughout the whole industry. This is not just the build-to-rent sector. It’s something that concerns us because obviously, with Brexit coming down the road and if we are unable as an industry to get access to the labour we need, that will have an impact or will amplify those construction costs. So, it is a challenge. It’s not one that there’s any one magic bullet or solution to solving. People talk a lot about modular construction as a means of, if not necessarily bringing the cost of the construction down, as a means of speeding up the delivery. That’s something we’re quite excited about as a company too and we’re looking at different ways of introducing that into our business.”
If one looks at the housebuilders, they’re obviously very profitable, I say, and have been doing very well recently. “They’ve had a little bit of government assistance, I would argue. Policies like that frustrate me because all that’s doing is dealing with the demand side, which needs no further stoking, and not addressing the supply side. Because dealing with the supply side is just too difficult. It goes in the Too Hard To Do box. And that’s a shame. Governments live in these five-year short burst political windows where they are unable to deal with and tackle that problem because it would take things like consensus and probably decades to figure out. Administrations just don’t have that luxury. When they re-announced another round of Help to Buy, I think the build-to-rent industry and frankly, people in the wider real estate world, heaved a kind of sigh of disappointment. Unless your name is Housebuilder Plc, then it’s not going to be a helpful thing.”
So do you think the UK will muddle through somehow? Will it ever solve its housing problem? “That’s a big question. I’m genuinely fearful because I think we are living in a world now where you have haves and have-nots. And never before has that been more amplified, or the polarity of that been greater, where if you own real estate and you have equity, you lead a very different existence to somebody who does not. The more that problem exacerbates, I think you run the greater risk of seeing potentially social unrest. I don’t know where that leads. The government has a moral duty to house its populace. Build-to-rent can form a part of that, but it isn’t the solution. It’s something that concerns me. And not just on a UK level but on a macro level too. I think you’re seeing that frustration start to be borne out whether it’s voting for Donald Trump or some of the more populist governments that you’ve seen, both on the right and the left in Europe. Trickle-down economics hasn’t borne out in a way that we all thought that it would.”
