This article reviews the financials of two major types of modern standardised housing markets:
- The conventional Open Market Sales and
- The newly developed Build to Rent (BTR) housing system.
Both these concepts differ from each other in terms of financials measuring, payback periods, and gaining value.
In the Open Market Sales strategy, developers build a residential area to sell it to occupants as individual apartments. They have the liberty to use the property for themselves, or to rent it out. Open Market Sales encourages private landlords to rent out their houses or apartments to individuals.
In contrast to this, a BTR scheme is completely owned and rented out by Institutional Investors. Open Market Sales has been the preferred housing policy in the past. But, as people’s lifestyles and the job market took to the fast lane, a need for a more adaptable approach was needed.
With BTR, an entire development will remain owned by the developer or investor. This property is then leased out individually to tenants. Funds & trusts that follow the BTR strategy, put their investment into big cities schemes. This strategy works best for institutions looking for reliable and stable income over time, at a lower entry point. According to BMT Quantity Surveying Company’s report of 2019, BTR investments are more feasible than the conventional Open Market Sales system.
As the demand for rented property grew in the UK, developers saw BTR as a perfect way to profit from ‘Generation Rent‘. Moreover, this policy allows the tenants to enjoy better services in terms of quality and experience.
Financial Measuring Metrics
Firstly, Build to Rent and Open Market Sales have different sources of earning profits.
Open Market Sales uses the old school method of charging a percentage of profit and return on the capital. To estimate the profit from Open Market Sales, we use the absolute profit technique as the most reliable indicator of development. As for cost, the value of the land, the cost of building, and the price of the final product are hence the key financial indicators considered.
In contrast to this, BTR uses a sophisticated underwriting method when calculating the financial metrics. The primary method of calculating the financials, is the Internal Rate of Return model (IRR). This method uses the rate of return of an investment. As the name depicts, this method only includes the internal factors, omitting external factors such as inflation, capital cost, risk-free rate, or financial risks. In other words, this method is the discount cash flow rate of return. Unlike in Open Market Sales, yield returns are used as opposed to the return on the total cost. Yield refers to income return on an asset. The return on income includes the interest or dividends earned on an investment. It is articulated annually in terms of a percentage of the cost of the asset.
Payback Period of Build to Rent Financials
Another significant difference between the two housing systems is the period of payback. In the case of Open Market Sales, the payback period can be between 18 months and 3-4 years. To clarify, the payback period is the time needed to retrieve the funds employed into the investment. The impact of timing and delivery is not as much, as Open Market Sales use the marginal profit calculation method. Timing matters more in Build to Rent, because it relies on the internal rate of returns.
For BTR, the time to reach the break-even point is more than double of the Open Market System. It can take between 11-25 years for investors to earn back their initial investment in property. This depends on whether they choose to sell on the asset. However, while the payback period of the BTR system may not seem attractive at face value, other qualities entice investors.
Gaining More Value in Build to Rent Financials
The Open Market system & the Build to Rent system are both reliable for maximising capacity.
Open Market Sales are best employed where the demand for property is high. It works well in areas where commercial spaces are in close proximity. With the area already commercially established, it attracts tenants with income to spend. The more urbanised a district, the higher the demand for housing.
On the other hand, Build to Rent developments can thrive in commercially established areas as well as quieter ones. BTR is beneficial where the cost of purchase is too high. London is a prime example. Alternatively, a BTR in a non condensed area can host gyms, supermarkets, restaurants & other amenities. Reducing the need to be in a bustling area whilst also attracting new businesses. The infrastructure, businesses, and facilities are all designed, with the tenants in mind. With high competition from other housing markets, the facilities & quality are imperative.
Conclusion
Whilst both developments have their pros & cons, both strategies serve different purposes. Hence, the difference in the financial metrics used to calculate profits. And the differences don’t stop there. Unsurprisingly, business strategies and marketing methods also differ greatly for both.
Build to Rent schemes are comparatively new, but it is quickly catching on. The ease of living & community feel that come with living in a BTR is hugely attractive. Especially for people with busy work lives. So, having all the facilities, along with security, pulls investors in strongly. Build to Rent focuses on minor details, making sure every aspect and requirement is perfect for its tenants. Creating more certainty of occupancy for investors. Ensuring they achieve the long term payback period that is so fundamentally different from Open Market Sales.
Subscribe
Every Friday we send an email with that weeks published posts. Subscribe to our weekly newsletter to make sure you don’t miss a thing.