Understanding the economic pattern of a market is a necessary piece of information for diligent investors. As is knowledge of the pattern in which your choice of investment flows. Recent economic turmoil within the UK has shown us that, unlike most investments in the property market, the BTR sector takes a different pattern than the usual economic cycle in the UK. This begs the following questions; what is the property cycle? How does the Build to Rent sector differ? And, what are the pros and cons for the long-term feasibility of the Build to Rent sector?
The UK Property Economic Cycle
The Property cycle is a sequence of recurrent events available in demographic, economic, and emotional factors that affect supply and demand for property and subsequently influencing the property market.
The UK property cycle, just like most developed countries’ today, follows this same predictable pattern. The property cycle when observed, can have three distinctive phases being the Boom phase followed by the Slump phase then the Recovery phase which kickstarts the Boom phase again.
The Boom phase is characterised by a high demand for landed property which in turn leads to a rise in the property prices. Since land is a limited resource, eventually, property prices increase faster than average salaries and properties start to become unaffordable.
Heralding the next phase (Slump). Property prices stagnate or plummet due to an increase in rentals of landed property. Causing a problem for the banking sector, as loans were safe against the formerly high-value property. All bank loans suspend in turn halting building and business activities affecting the whole economy at large i.e. the stock market and employment levels.
Until property prices drop to a sustainable level, only then does the recovery phase commence. And people characterise it by the increased rents and cash flows; gradually everything returns to normality and the cycle restarts.
The Economic Cycle of Build to Rent
The Build to Rent sector is regarded as acyclical. The financial performance of the sector is typically negatively correlated to the general state of the economy i.e. Build to Rent developments move independently of the overall flow of the economy. As a result, it is to a great extent unaffected by the fickle changes in the property market. The continued strength of the sector through COVID-19 pays tribute to this fact.
Since the Build to Rent sector follows a more acyclical pattern it is bound to outperform cyclical based sectors. Even rise during economic downturns or recessions, making them extremely strong diversifiers for an investor. Given that the Build to Rent sector is a landed property investment it will remain a relatively safe and stable investment plan in the property market.
Shortcomings of BTR Acyclical Form
Location saturation
The Build to Rent sector could experience a slump where there is a saturation of developments in a location. A Build to Rent development can provide over 500 units. Having a vast quantity of such developments in close proximity would be detrimental to the value of the units.
This brings us back to the Law of demand and supply. The prices of Build to Rent apartments will need to remain competitive in a saturated market. It may offer incentives to tenants that may not be accounted for within the underwriting model once there’s a saturation of developments. It could potentially lead to a failure of the investment predicted yield.
We should put a critical analysis of the long-term growth and depth of the market of the location into consideration when building a BTR development. Currently, in the UK, certain areas are already experiencing the adverse effects of how saturation dwindles the demand.
The rental situation in Wembley in London is a prime example of how too much supply can dwindle the demand. Lewisham is also on target to have over 3000 Build to Rent units in close proximity over the coming years. That’s why it could suffer the same fate. So, it is in the best interest of the development to identify locations with long term rental demands.
Letting Period
Build to Rent developments can potentially flood the rental homes market within an area, the period it takes for the development to fill up, is the letting period or lease velocity. This period can either vary depending on demand, location & marketing strategy, among other things. Keeping this period as brief as possible is in the best interest of the investors who will look to drive the development to stabilisation as soon as possible to increase IRR.
Is a Build to Rent a Safe Investment?
The acyclical form Build to Rent takes, shields it from the trivial changes that occur in the market. The concept of ownership of a Build to Rent development is in a way to protect the investor’s funds. This is due to the developments being managed by a company. And investors own it collectively rather than selling to individual landlords or distributed amongst investors. Guaranteeing the investors, a fairly stable and long-term income stream. Lastly, the option of a long tenure rent provides a sense of long-term security on investments.
Conclusion of the Economic Cycle:
Build to Rent will have times when it flourishes stronger than other property sectors. And times will come when it struggles to reach the underwriting targets. However, in the grand scheme and looking at the cycle at a macro level over 25 years BTR looks to be a continually safe investment.
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