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  • Writer's pictureAnna Clare Harper

The future of Living Capital

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Anna chatted to Simon Scott, Lead Director, Living Capital Markets UK at the second largest global property advisor, JLL about the future of ‘living capital’ (which is essentially the institutionally-funded segment of the real estate market which people live in).

Topics include:

  • What we can learn from 2023 around the resilience of residential investment

  • Factors influencing investment valuations, from fire safety to operating companies

  • Will 2024 be the worst year yet for new housing developments?

Listen in here:

This transcript is AI generated. Please excuse any typos.

Anna Clare Harper: Hi, and welcome to The Return: Property & Investment Podcast. I'm Anna and I'm delighted to be joined by Simon Scott, who is lead director living capital markets UK at JLL, which is the second largest global property advisor in the world. Welcome to the podcast Simon, thank you for joining me. Today, I would love to get your take on the future of living capital markets, but focus on what I would call large scale residential investment with a particular emphasis on single family housing. Before we look into the future, though, there's often a lot that we can learn from the recent past. So I guess just reflecting on 2023, I wonder if you could share some of the key insights or lessons that the residential investment sector in particular has learned.

Simon Scott: I guess, to a lesser extent, 23's at similarities with a pandemic. And by that I mean, obviously an environment that was materially affected from an investment perspective, which put people on edge in terms of making investment decisions to purchase. But fundamentally, what's actually going on on the ground has been incredibly resilient. So I don't know how many of these sorts of markets we have to go through in order to demonstrate to the investment community. And then I think in all fairness, we pretty much are there, it's just relative pricing now becomes more of an issue or something we come on to that later. But the resilience of what residential as an investment asset class has, and particularly in times of greatest market volatility, I think is unquestionable. I think again, '23 is another really key example of that. I mean, you think about some of the predictions that were made about house price falls and crashes and so on as a result of increases to the interest rates that we saw. And fundamentally, that has not happened. So I think that would probably be my biggest takeaway from the joys of last year.

ACH: I completely agree with that. And especially in the context of all the kind of turbulence globally, there was so much that happened and to remain so resilient. What does that actually mean now for the future? What does that you know, I suppose that lesson, that example of resilience, that we've seen another example of resilience of the residential market, what does that mean, for and beyond?

SS: Yeah, I mean, I think the key thing is just insulation of value. So insulation of value, and the ability to maintain an income stream off the back of the investment that you've made. And if we think about the vast majority of investors, and the long term investors within the build to rent space, single family housing space, if we're going to focus on that, particularly today, it's about a steady state of income that matches liabilities, and yet retaining the resilience of the assets that you've acquired. So we did a review on a couple of portfolios that were available in the market last year or the year before that failed to sell as a result of the challenges that the Trussonomics budget brought about and that sort of market insecurity. And putting us somewhere between 75 and 100 basis point movement into those cap rates, we were still generating a price that was equivalent to much, much cleaner yields as a result of the tremendous rental growth that we've seen in the sectors as a whole, because of the shortage of supply that's coming through and the demand for good quality product, that to me, it's a pretty defensive asset class. So you're maintaining a high level of income reflecting the outward movement in yields, and the resilience of the underlying real estate. That I think is the fundamental behind why residential investment assets are such a key part, I think, as we move into the next phase of sort of confidence, I think returning to the market.

ACH: Okay, so a big lesson being to have this as part of your portfolio. What happened to those portfolios, by the way that you mentioned?

SS: I think they are still available, and letting up. So again, a lot of the work that we do, should be well aware, a lot of the money is chasing development opportunities, because you can't buy the stock because it doesn't exist in the same way as it does in the US or Germany, where you have well established residential investment markets, we obviously did, going back to the 1960s. And obviously, rent control took place there. And we're now in a position where that market is being rebuilt. But it's relatively small steps. I think the BPF produce regular statistics on the scale of the build to rent space. Should I think, yeah, it covers the single family housing market. But I think in combination, we're seeing a big influx of new supply in the market, but it's few and far between at a different level. And at the end of the day, I think also a lot of the developers that are active in space, recognise that potential, if they're well capitalised, take the route, you know, the demands there. So that risk is pretty limited. And certainly when I talk to my funding colleagues about appetite from the banks, to support developers within the space, they're very keen to get exposure. So actually, that takes the pressure off the developer from having to then turn to the market that they would like to. But at a price, they probably don't want to when they can see the fundamentals are strong. And certainly it's, you won't need to seek very hard to find a developer, he'll tell you how difficult it is to get planning and how long it takes. Yeah. So when you've gone through that process, and all the challenges around development that clearly exist, why would you give such a prime asset away? You just wouldn't. That's an element of I think what we've been seeing, and perhaps one is sales yet haven't come to a close.

ACH: The next question I was going to ask you is around the capital living market, and the kind of significant trends and emerging dynamics that are shaping it. But I suppose as part of that, it would be helpful if you could just explain what capital living is, and how it relates to traditional residential investment.

SS: The next question I was going to ask you is around the capital living market, and the kind of significant trends and emerging dynamics that are shaping it. But I suppose as part of that, it would be helpful if you could just explain what capital living is, and how it relates to traditional residential investment.

ACH: Okay, so and it kind of, to me, it sounds like what you described as living rather than capital living is needs based demand effectively. Whereas, for example, a hotel typically is less, more want and less need, is that kind of aligned with what you're offering?

SS: Yeah, it's an interesting way of thinking about it. That will be again, another sort of differentiation in terms of those sort of asset lines, I guess.

ACH: Okay. So and so what are the significant trends and emerging dynamics and living capital markets?

SS: The most significant trends is clearly this ongoing allocation to living assets. I think for the first time, I'm not sure we've completely fixed but I think we are now neck and neck with offices as the biggest investment class or certainly in the UK. We were law last year, so that's a massive change from institutional capital.

ACH: Because as a size residential is way bigger than commercial, in total.

SS: Yeah. And again, I think that's one of the sort of anomalies. The problem is, is capital markets ready, that's something that often gets quoted back to me you can't buy at scale. Or, as we all know that it's probably as easy to buy a million pound house as it is to buy 100 million pound development. And if you're trying to allocate, and Darren says, you just segwaying quickly back to the sort of focus that he wants to talk about this morning in terms of the emergence of single family housing. I think that's sort of, that's why people I think, jumped into multi, because they recognise they can deploy capital at scale in a single transaction. Whereas even if you're buying for a house builder, it might be 20-30% of the scale of what we normally see. And so most of the transactions that we've been involved recently in the single versus multi is probably 20 to 30, as opposed to 100-150 scale. So there's quite a big variation in terms of that sort of capital allocation. And yet, the time it would take to deploy probably very similar in terms of that legal commitment.

ACH: And that legal commitment, and the strength of title rights is one of the key things that underpins their resilience that you described earlier. So it is pretty important. So that's very helpful. One of the kind of really critical perspective residential, in particular areas, the balance between supply and demand, what are the primary drivers or challenges that are affecting that equilibrium or balance at the moment? And I wonder if you have any kind of notable statistics or insights on the single family housing space, in terms of supply and demand at the moment?

SS: Yeah, I mean, I think the expectation is, whether they are, shall we say, nailed down targets, or just aspirations in terms of producing something like 300,000 units per annum, being set by government, which is nowhere near it. And I think one of the predictions that we made at the start of the year in the research team, is that we'll probably see the lowest level of supply during '24, than we've ever seen. And I think fundamentally, that is a big, big problem. And there are a number of reasons for that. I mean, planning is clearly one of them terms of the process. And I think clearly, that's going to be very relevant in terms of a lot of the politicking, we're going to see over the forthcoming months as we move into a general election. So I think that's a major barrier. I think, certainly, when you're looking at sort of city centre, high rise, multifamily developments, from a viability perspective, even with the rents, the nervousness around a fire safety, around providing relative risk returns to the developer, that really difficult to make work, regardless of where you are. So there are a whole sequence of challenges that I think particularly in an urban environment, make the delivery of high rise multifamily really difficult. And then you take the challenges around single family paths into sort of suburban context. And that's not easy, either. I mean, the house builders are your critical supply in terms of new supply coming into the market. And I've certainly done a number of cycles. And we've certainly seen the likes of history and a transaction that they've recently undertaken with Blackstone, I think is probably the perfect example of that, of them pivoting their business plan into dealing with large scale investors into the sector.

ACH: Can you provide some colour on that?

SS: Well it's a mix this through the lease and sage platforms, we weren't directly involved with the transaction. But in super basic terms house builder, does a bulk deal with Blackstone, through their platform lease and sage stage looking after the shared ownership doing market for rent, approximately 50/50 in terms of split the assets 819 million pounds worth, so I think that was a massive tick for the sector in terms of demonstrating the confidence that probably one of the best respected private equity investors in the world have into the single family housing space. So that's how I read that too.

ACH: That is exactly the kind of answer I was hoping for. Okay, so any other hot tips for single family housing sort of sector or segment or people who are interested in this space, things that they should be aware of?

SS: Yeah, I mean, I think the granularity of it, I think it's a really important thing. It gives you flexibility optionality. So let's give some private equity terminology gives you optionality around how you manage your resource One of the things that you'll see from a multifamily perspective, if you sell one or two units within a massive block, then you negatively impact your investment value and the way these things are appraised. If you sell one or two individual houses on the edge of a housing estate, that's not really going to affect your underlying investment value. So that gives you the option to crystallise capital if you haven't situation, but around redemptions. And it gives you much more flexibility in terms of how you can manage your estate at certain points as well, where you may not have that from a multifamily perspective to the same degree. I think some of the other positives that I've heard cited within the single family housing space also around the operational costs, you tend to be running a less amenitized product within single family housing. And I think there'd be I noticed as a subject very dear to your heart, and but how tech actually might enable you to provide a better level of, I suppose engagement with your occupied room, your customer set. In a single family housing perspective, which we've not really seen in the UK, I think it's interesting to see what was in class based in the States within the single family housing space as well, is they were relatively late to the opportunity to build and scale within the single family housing markets as well in the States, which is where we often go to for our sort of precedence. So I think there's some really interesting conversations ongoing as to how I think that market is going to evolve, more and more capital looking at it. I think that the barriers remain the same that actually if you're going to develop a strategy within that space, how can you get scaled quickly. And I still think that remains a challenge for most investors in this space. I think it's interesting with people like Alan G, who obviously set out on a course where they were looking at multi pivoting into single family, long harbour, again, one of the principles Moda with their Casa by Moda mode or offering how many have shifted into looking at single family as part of their menu of offers to their institutional capital. So I have no doubt that we'll continue to see the depth of market and investors within the space grow over the forthcoming years.

ACH: So valuation, and you kind of touched on some of the components in it are various points through this conversation. But I guess just to kind of just to dig into that topic, valuation. Valuation is clearly critical for investors. And there are some really interesting influences in print trend for like the impact of single core on a building valuation relation to fire safety and changes in regulation. And another might relate to the kind of changing popularity of specific ESG certifications or scores that a building might have had. And then that goes up or down in popularity. I wonder if you can outline some of the shifts in valuation and how investors are adapting to these changes?

SS: Well, I have to put my hands up and say I'm no longer a registered valuer. But I suppose from the outside looking in from a valuation perspective, the thing about dual staircases and that changing legislation, there are undoubtedly some investors that, frankly, do not feel comfortable buying anything that doesn't have a dual staircase going forward. There are other investors that are entirely comfortable with it. So I feel a lot of empathy with my valuer colleagues, in terms of how they approach that quandary.

ACH: Let's talk about the just talk about that, so that everyone's on the same page as well. So essentially, buildings, well, you might be able to explain it better than I can, but the previous standard has changed. And subsequently, there's lots of buildings that have been built to the old standard with one core.

SS: Completely compliant with the building regs for their time they've moved to over a certain height, you have to provide dual staircase exits. And that's created a lot of challenges. And obviously, the whole issue around fire safety, quite rightly, is very much front and centre when you've got institutional capital looking at, again, one of the big challenges of getting institutions interested in the living space was reputational risk. I mean, for me, that's what makes it exciting and personal. That's what it is. So that if you're simply looking to allocate capital, that is sometimes a challenge that people get nervous about, and therefore all the challenges about health and safety when you're talking to asset allocators, and how that would fit within their within their way of thinking. So just getting back in terms of what that actually means to value I think at the moment, because the market is absolutely dominated by single staircase, staircases. For me, it's probably more an issue around depth of market. And investors who aren't prepared to pay. And it's a case of how you operate those buildings and there's great operational businesses out there at the moment. So I think a lot of those concerns are probably a reflection of the importance that people see in it. But it's also just being overcautious. It's absolutely right to be aware of it as an issue. But maybe we swung too far the other way. So I think that's probably what's been fairly reflected in the valuation market. The big one that floats around a lot is the discount to vacant possession value, which is historically obviously the way that residential investments have been valued more commonly, most commonly now, it's very much an assessment of its net operating income, and much the same way, as our commercial colleagues would appraise a commercial asset makes absolute sense. I think it's probably even more relevant to single family housing, some of the conversations you have about trying to apply premiums to single family when they're not stabilised and unproven. And why would you pay more than someone on the high street for the same unit? I don't quite get that. So I think all of that is in the pot is a moving feast. We've certainly seen valuations undertaken premiums in excess of aggregate taking possession of value for multifamily. I don't think I've yet seen that done in single, but I've certainly seen a very close correlation to it.

ACH: Just on that, one more question, because since you mentioned the operating company, I suppose, where you've got, for example, a big block of multifamily. One reason why someone might pay more than the vacant possession value is that they want to access scale. And because scale is attractive in one go, they're willing to pay a bit more. Another component, as I understand it is you know, the value that the operating company brings, can you just talk a bit about that, and how that because that seems to be a bit different from an office, for example.

SS: I think in terms of, I suppose that fully integrated model is about sort of balancing or ensuring that the greatest respect to some third party managers, I think the biggest issue was the appointment of third party managers is a concern from the investor, that their asset when they're competing with another managed by the same entity who gets priority, if you're operating your own assets, through your own integrated operational platform, there is no argument. And even if you've got assets in the same city, you will allocate according to your business plan or your strategy. So I think that tension goes away quite quickly as an owner operator, as opposed to appointing a third party, and it is a control thing as much as anything, I think in terms of that full integration. Does that answer your question?

ACH: I think so, please correct me if I'm wrong. I think this is super interesting. And important. I think what you're saying is, you know, there's value add in terms of being able to control the management of a building in residential. And that is why people might pay a little bit more for the company that they control.

SS: Absolutely. And I think I mean, some of the leading protagonists within the space, that sort of Instagrammable culture, the sense of community, probably, it's better way of putting it that they're trying to create that sort of brand identity that they're attaching to their assets, is what sets their building aside from the one next door. Let's go back to the hospitality sort of, we all know that there are different subsets within the hospitality space. So you can go absolute prime, or you can just get effectively a bed bed for the night. Yeah. So where do you want to be? And I think that's what we will, as our markets, as you see in the States, you'll see different grades of property and may become as a result of timing and different trends and fashions. But my expectation is that you will start to see a greater spread of those different grades of multifamily products with single family products, and they will have a place. But I think the big challenge when it comes to viability is that you tend to have to deliver the higher levels. I mean, one of the big challenges, one of the sort of big areas that I get asked about a lot is around how do you deliver more affordable residential accommodation at scale? And the challenge is, it's really unviable. So it's not that people don't want to invest in it, or there's not an even bigger occupy group that wants to rent in those sorts of things. It's that you can't deliver it, unless something breaks the viability gap, which is highly unlikely, then it's going to be the upper end that you're going to see more suppliers. I think it's more a case of where you start to professionalise more on the existing kits. And I think recognising the affordability challenges that we all have. Yeah, I think that will be where the market goes building that scale. I think going back to the valuation point. I mean, I think you can certainly see a day where a much greater appreciation of the income streams that flow through from these assets, probably negates that differential. And actually the way that you can move the numbers around in terms of what sits in the operational business relative to the real estate will help them differentiate.

ACH: So given the kind of growing emphasis on sustainability and and responsible investing, how do you envisage the landscape of responsible residential investment evolving? And are there any kind of specific criteria or practices that you think will become more prominent in shaping the future of responsible investment in residential?

SS: I think it's front and centre now. It's certainly a conversation I have much more regularly with investors about social impact. The legislation around the EPC, grading, raiding, obviously, being dropped by current government, I thought was interesting. And I say interesting on a number of levels, insofar as I think the reality of actually be able to hit those targets, and translate what is a housing stock that is much older and less energy efficient, was probably in all realism, unachievable within the timeframe that was set. So that can, to me feels like it's been kicked down the road. But for me, there's a real recognition and actually even chatting to some sort of local estate agents in a region recently, you're actually seeing investors buy to let investors Mom and Pop landlords actually already leaning in and recognising that they need to upgrade the quality of their property, even though they might not need to within '25, '28, '30, whatever the timeframe was going to ultimately end up. I think that's coming. And I think we're seeing early signs of people already bringing that forward, certainly the institutional community that I talked to very, very focused on highly efficient buildings. I know you're good friends with some of the team at Octopus, and what they're doing with zero bills, I think is brilliant. And well, we'll see more of that rollout that affects the affordability that had the massive impact, I think on people's well being as well, in terms of so I think all of that is really intertwined. I think some of the changes coming in terms of the rental Reform Act and security tenure, I think, again, really plays into where the institutions are coming from and offers real benefit. I mean, certainly, from a personal perspective, when I've looked when I've rented in the past, it is one of those things that hangs in the back of your mind. I could be out of here anyway. Yeah. Whereas actually, when you're looking for the long term income, again, there's sort of perception that the landlord's there to try and make a quick buck. Actually, the vast majority of the institutional investment capital I'm looking for that's the last thing they would they're considering they want that continuity of income, they want that happy tenant, they want to do good with the capital that they're deploying. Residential in that sense, has to be, in my opinion, it has to be the best place to put their capital to work, particularly when I don't think there's any disagreement that we have such a significant supply demand imbalance.

ACH: You mentioned what you would do brings us nicely to the final question I was gonna ask you. So if you had 100 million of your own money to invest in 2024, and what would you invest in? And why?

SS: Well, it may surprise you to learn, I'd probably invest it in residential. I suppose what would I do try and balance that out. And I think sort of parking students and later living, which obviously have to fly the flag for I think the thing is a really interesting urban solution. So I'd also like to make a little bit more on the 100 billion in additional investment. I think that to me feel slightly underpriced. So I think has a really interesting point to play in the market. And I think more of that will help some of the challenges that we have in the housing market. So it's not the answer, but it is one of the answers, I think. So I would put a little bit of my capital to work within that space. And it's funny when I dust off the grey matter, and when I first started working within the residential space, which has nearly three decades ago, and the really early interested investors, so people like IMG and Schroeder's setting up a residential property in a trust, their targets were sort of 30 to 50 apartments. And I think that a lot of the work that you've seen people like Sigma do in low rise resi in alongside their single family housing acquisitions, for me, I think that feels like the right stretch that that would be where I'd be playing.

ACH: All right, well, if listeners want to find out more about you or follow you or JLL or just get in touch, what's the best way for them to do that?

SS: I guess the website is probably a good start and return. Email me direct on cyber or I'm on the synonomous LinkedIn platform as well so any of those formats.

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