What does the Build to Rent sector look like today for lenders and borrowers?

Andrew Yates: As is it has just come up 11 o’clock, I’ll kick things off. Thanks to everyone who is joining, and [inaudible] at the moment, I still can’t completely get used to doing these things on Zoom and Webex, but I suspect everyone’s well used to it now, knows exactly what they’re doing, how to put people on gallery view.

And this is the next in the ongoing series of webinars that the BCLP Real Estate Finance Team have been doing on finance issues, going through the Covid-19, the pandemic. And today what we’re going to be aiming to be looking at, is, specifically, the build-to-rent sector, what’s going on in the build-to-rent sector, and what are the opportunities there in terms of debt and investment, and how’s it going. And I have to say from a personal point-of-view, discussions with developers and investors at the moment, this is an asset class that is seen as a likely candidate for success going forward, there’s lots of positivity out there about its potential, and it’s seen as a very defensive asset class.

So I’ve got two of the sort of leading experts in the market with me today. We have Rajesh Shah, who’s an Executive Commercial Director at Quintain and Tipi. He was involved in setting up Tipi back in 2015, and he’s leading on new products and service proposition at the moment too, as Tipi evolves. And we also have on the banking side, Hugh Taylor, who’ll be familiar to most of you as well. Hugh is Head of Housing UK at HSBC, part of their corporate banking team.

So, to get things going I thought it would be useful to start off with an overview of what’s actually been happening in the market – is it positive or not? And I think the best person to give us an overview is someone who’s been at the coalface of that, so Rajesh, can I hand over to you?

Rajesh Shah: Yes, of course, morning everyone. So I’ve been involved with Quintain for 12-odd years, and as Andrew said earlier, started up Tipi in 2015. And just a bit of background first, as part of the journey to set up Tipi, like most people would, we did some research into the U.S. market, and so in 2015 I looked at, you know, a lot of broker reports on the U.S. and the multi-family industry there had been going for 25, you know, 35-odd years. And one trend came about, which is long­term, if you look over 30-40 year horizon, whence they have been steady, they’ve been growing, you know, two to three percent every year. And, if indeed you look at the last big downturn which came there in 2008 and 9, was residential values fell massively. What was noticeable, very obviously, is that rental rates remained flat or barely fell, in fact, and that gave us a lot of confidence in terms of setting up Tipi within Quintain at Wembley Park.

At the same time, since 2008, Quintain at Wembley had also been selling apartments to the private investor market, by 2015 we had about 250-odd, which sold mainly to investors, but we had an in-house estate agency firm which is managing those. And if you look at the history of rents within that part of the sector within Wembley Park, they’ve been growing steadily again at two-and-a-half, three percent a year, and our occupancy rates are sitting at 98-and-a-half percent so ... a lot of this gave us confidence about where the market is on a long-term basis, but if you look at what happened to us in early they said no one had ever encountered a full and proper lockdown, so generally in a recession, things slow down quite a bit, you know, retailers struggle, unemployment goes up.

But a lockdown no one had experienced so ... it was generally unprecedented times for everyone out there and, from our perspective, you know, very quickly, and, you know, as good as overnight, it was, you know, with the lockdown in plain, no one was milling around, no activity was happening, the streets got deserted, and what happened obviously is that leasing activity as good as died to literally nothing.

So, we had a few people who had reserved prior to lockdown. In many cases they changed their mind and, you know, you can understand why they did so. So the first four or five weeks after lockdown we had, you know, as good as net zero activity. And as gradually I guess people getting settled and understood what lockdown means and a bit of, I won’t even use the word “normality,” but a bit of, you know, I have to do something more with my life, you know, came about. So we noticed second week in May activity levels started to, you know, slowly trickle upwards, and if you fast-forward to where we are today, we have a lot of leases coming our way, but come back to where we were projecting before we are, you know, we are circa 50 percent of level of activity we had been, you know, projecting at the start of this year.

It’s made a big, big difference in the way we look at our business, and, you know, generally I haven’t got a crystal ball, I don’t know how this is going to pan out, but some of the factors which have given a lot of comfort are, you know, if you look at rent collections, that we hear a lot of big headlines about retail and commercial rent collections but across the build-to-rent sector, we are capturing 95-plus percent rents, you know, which is a very, very good place to be, and back to hence my story about where U.S. has been over long-term. And there have definitely been people, a lot of our residents have struggled because of furloughing, because of job losses, but we have, you know, way below one percent of cases where we have been working with residents on payment plans, so the overall factor in this is actually income levels remain pretty strong, stable. Rents haven’t dropped but inevitably, what we found, is occupancy on our stabilised buildings have, you know, fallen a bit. Lease sub-rates for new buildings have equally slowed down, and we’ve taken a lot of lessons how we, sort of, evolve and learn from it. What we have, though, done as a sector, and Tipi in particular is, when lockdown seized, the thing we could have done is, you know, say it’s, you know, the whole market is, you know, going crazy out there, we’re going to just wait and see what happens. Instead, we took stock and looked at other parts of the businesses where there’s finance, where there’s operations, how we deal with technology, in which we divert a lot of the attention to improving those to take stock of, you know, where residents are struggling, how we can improve the services. And so we evolved our business over the last three or four months to tackle those aspects so that when normality does return, we are in a much better place in the long-term and we can deliver ultimately for us a much better customer proposition.

Andrew Yates: Alright, thanks. There is a couple of themes there that come out, I mean, it, it generally it’s holding up well, but with some issues, and at the same time, a number of other investors seem to be hovering around in the wings, looking for new opportunities, and I have spoken to a number of developers recently, who on the point of taking potentially quite large schemes out to market. And, so, in that context, Hugh, it’d be good to sort of start off with the general banking position.

Are you going to be lending into the sector, and if so, who to, over coming months?

Hugh Taylor: Yeah, morning everyone. Can you hear me?

Andrew Yates: Yep.

Hugh Taylor: Yep, great. So just to continue the introduction I will just sort of outline the HSBC housing team basically is involved in supporting clients with debt and capital market finance in the build-to-sell, build-to-rent, social housing, retirement housing, and purpose-built student accommodation sector. So, we have a sort of read across the housing sector as a greater whole, but to this specific question, you know, where are we and what we’re going to be doing? So, as a high street funder, we’ve had across those sectors I’ve just outlined, you know, been involved in providing business interruption finance sponsored by the government, to a number of players in those sectors; and, you know, of course, it’s in the public domain what, you know, quoted companies have accessed the governments commercial paper scheme as business interruption financial support. Interestingly, I’m not aware of anybody in the build-to-rent sector that’s had to take business interruption support. So, it’s sort of like as Rajesh is saying and as you’re implying Andrew, there is inherent strength within the build-to-rent sector.

What I would say is at the moment whilst this business interruption, wave of business interruption, request that we have received are supported by government guarantees, they nonetheless have an impact on the banks’ balance sheets and their capacity. Now that, of course only applies to lenders that are involved in supporting the scheme. So there are, you know, for example, unregulated funders in the build-to-rent space that would be impacted by that, but I think it’s true to say that if you look at most sectors there’s, you know, heightened risk at the moment to, you know, use or to steal Rajesh’s expression, we’re not in normal circumstances just at the moment. So, I would say that I would characterize us from a background as being a fairly significant participator in this sector in a number of forms in support in a number of clients; but there are clients that have, you know, fat on their back, they’re inward investors, they’re probably, you know, more conservative lends than what other players might be involved in generally and I would say that at the moment we are looking at proposals and probably exclusively I would say to, you know, from people that we know, so there’s a sort of like, relationship aspect to that. So, we’re looking at a small number of large transactions at the moment that give risk mitigation in terms of being multi-site projects in at different stages. Some are stabilised, some are in the course of stabilisation, some are new build for example. So, there is activity going on, but what I would say is I think generally speaking the big issue that everybody is looking at I think, relative to build-to-rent, is what happens when the furlough scheme ends, what that does to the client base of the build-to-rent operators and what decisions those individuals make and what the consequential impact on occupancy level and thereby revenue is.

Andrew Yates: Can I just pick up on a couple of specifics, Hugh, within that context, because Rajesh mentioned a couple of the common themes that we’ve been seeing in the market, around the more negative elements on degrids slowing up in lettings, lower expectations on rental growth. On the specifics of the build-to-rent lending, what does this mean for you as a lender when you look at issues like stabilisation; when stabilisation is likely to happen, exit? So, interest cover test, loan to value, those sort of specific financials in a build-to-rent context.

Hugh Taylor: I think...at the moment in the context of a single purpose vehicle, a special purpose vehicle scenario where you’re looking at a one asset in a standalone arrangement is quite difficult and hence why in responding to the opening question, I outlined the fact that we tend to be involved in deals that offer the spread of risk in terms of stages of where individual developments are in spread of risk in terms of location. I think not only are we dealing with Covid-19 in making those assessments, but we’re also to a degree looking at, you know, markets that are potentially new to build-to-rent and having to make assessments and judgements about that. What I would say is at the moment, Covid-19 is adding an additional layer of risk and I think it’ll be interesting, I think it’ll be a much easier situation to make judgements upon, you know, towards the end of 2020 as opposed to the end of the summer of 2020.

Andrew Yates: So are you changing how you approach things like interest covered loans and value tests at the moment?

Hugh Taylor: No, I wouldn’t say so. What I would say is there is a heightened focus upon financial models and testing assumptions, undertaking stress test. There’s a heightened focus for sure, that as for the overall approach changing, I would suggest at the moment not because, you’re dealing with a sector, they actually in the context of the overall pandemic epidemic, is actually performing relatively, really well. As I say, to the best of my knowledge, maybe it’s taking business interruption finance, currently rentals are holding up, it’s more about the inability to look in a crystal ball and make judgements about the future where investors and banks are buying into a long term story generally not a short term one.

Andrew Yates: One of the things that I’m hearing quite a lot from investors is that one of the things that seems to be holding up people from taking buy decisions to go ahead with things is this view that, there may be some distress opportunities coming up if they wait a little while, just looking at it from a banking perspective is that something you think will come about either, specifically in the existing build-to-rent operator sector or perhaps more likely in situations where you’ve got maybe some medium-sized developers and other players that are, that have got sites that can provide opportunities that they’re under pressure? What do you think?

Hugh Taylor: It’s difficult to pronounce on that, Andrew. I think what I would say is our perspective at the moment is we believe there may be opportunities and I review the word ‘opportunities’ where maybe somebody’s is reshaping their portfolio and trying to create cash by undertaking asset sales potentially at a discount. I think what is difficult at the moment is foreseeing any, what I would describe this as, stressed/fire sale situation emerging; and principally that’s against the background of the governments mood which has been supported by legislation from the corporate insolvency in governance bill which, I think, finally passed the end of June but has been in operation since March in effect where the government as an emphasis on a rescue culture, not one of, you know, allowing a free for all in terms of delinquency.

So I think at the moment the bank see the position as trying to support situations that I’m not aware of any distress situations in what I would describe as pure build-to-rent. I think the problem is sometimes a lack of focus or a lack of definition around some of the terminology and what does PRS mean? And where does PRS finish and BTR start? Depending on who you talk to, everybody has got a slightly different version of it; and I think there’s possibly some residential investors who would, who I would describe as, probably be being closer to sort of like almost overgrown buy-to-let organisations as opposed to build-to-rent, I see something totally different, and I think we’re dealing with modern stock, we’re dealing with stock that hopefully has green features around it which I don’t think the sector makes enough quite frankly. But, you know, you’re talking about, in normal times buildings with amenity space I think if you look, for me, purely at build-to-rent I think it’s in a good place comparatively to other property sectors; but, it does have an overhang of the issue that I’ve outlined relative to what its seeing linked to employment levels and what’s going to happen probably between now and the end of the year.

Andrew Yates: Yep. Thanks. Rajesh, as a borrower, as well as an investor and operator, bearing in mind all the things that Hugh said, what do you see as the opportunities are now going forward? Particularly in terms of things that you would be thinking about on how you’ll approach finance?

Rajesh Shah: Well, look, I totally agree with a lot of what Hugh said just now, and one thing which we need to put into perspective is also important from U side and the lender side is the quality of the operator out there, so you know one of things which hopefully does stand out from the build-to-rent sector, especially premium operators out there, is the amount of care and attention which is being taken on looking after the resident base. When lockdown started, everyone is protected within their own apartment, it’s difficult being in a building with a lot of social space you can’t use. It’s difficult dealing with shopping needs, deliveries coming through; and a key part of this is a good operator who spends a lot of time and effort communicating regularly, listening to the residents, just making sure their cares and needs are taken care of. The ample from that in the one sense, if you do any surveys like MPS, there’s HomeViews who do surveys regularly, and consistently what has been found is before lockdown and during lockdown, actually it’s been no change in customer perception of service level, and if anything, build-to-rent operators have been getting, you know, big thumbs up on security and safety coming through.

So from our perspective, working with lenders, one thing which has changed a lot and we have to be very open, very transparent, communicate how we’re performing whereas previously we used to do a report on the first day every three months for lenders. We’ve got currently about seven or eight different lenders with us and actually we’re doing regular calls and data sharing. So, just make sure that the confidence level from that perspective remains, but from data we’re sharing for the moment its showing, what I said before, very heavy levels of resilience coming through; and just to give you, from our perspective as a development contractor, constructor sorry, we’re working very hard with the four or five construction firms we have and we haven’t taken any steps to stop construction on site. We’re actively going and only because social distancing, some of things has slowed down, and we’ve got another site within Wembley Park nearly two in a half thousand units, because we see ourselves as a long term play operator, don’t want to make very short knee-jerk reactions to this. So we are about to kick start stage two design for the two in a half thousand site across Wembley which the first building opens in 2024. So we’re not pausing in any sense at all, and all the data coming from customers living with us and yes furlough and unemployment is a worry, but to us, more importantly if you really look after your customer base, the net impact on occupancy and lease operator would be minimised.

Andrew Yates:  ...and that’s interesting. Do you think when you get them to look at the market, as a developer, rather than just looking at it from the Wembley perspective, do you think that people are likely to be looking to other lenders who can be less conservative perhaps than the high street lenders are, given the issues that Hugh’s described about their balance sheet generally and what they are having to do.

Rajesh Shah: So, inevitably the answer is yes, because we will have borrowing needs and we want to make sure we can fulfill those to continue with our developments. What is still very important is the point about relationship lending, we do have covenants and some of them are a bit stretching within our portfolio. One example we have a developer lender with a lease up covenant in place, for the reason I explained earlier lease up is going to be much slower, is that relationship which makes to me a very big difference so yes, you can get cheaper lending in high LTVs, but in these more challenging times is that communication dialog, you know, long term working together, means actually we can work our way through these challenges and we have long history with lenders whose been with us for the last ten to twelve years. That would always stand in good stead for a position like this.

Andrew Yates: Hugh, where you’ve got people who may be looking in who are sort of looking at how they might structure schemes going forward in their potential lending options, what sort of characteristics of schemes do you think you are likely to be looking at? Is it going to be sort of less challenging schemes or approaches where developers accept that they can’t take profit out of PC they need to be waiting until stabilisation, what do you think you would be recommending to people?

Hugh Taylor: Yeah, I think there’s a couple things for sure, so, obviously the more a scheme can be D-risk, the more appetizing it would be to the majority of funders I would suggest. It would depend on the funders actual goals in terms of undertaking build-to-rent lending, so some may seek higher risk positions because they [inaudible]. I think high street banks want to do well structured transactions and take a reasonable level of return, or hurdle return for sure.

So, I think to the point you raise, I think anticipating profit that actually hasn’t at that point in time been made, in expecting a funder to lend for it, it’s actually, not something at the moment, probably too many people would tolerate I don’t think, or be able to accommodate. So, I think at the moment, we have a small number of transactions that are a reasonable size that we’re taking forward at the moment but there are transactions that we feel that would enable us to hopefully look beyond Covid-19 or the intensity of Covid-19 because of the overall package that is being brought to us. As I say, individual scenarios where there are uncertainly about let up levels where the local demand levels of competition, all these issues need to be sort of reconsidered. So, I think there’s some things there for sure, but the overall answer I guess is it depends.

Andrew Yates: Yeah and what have you been seeing with valuations at the moment? Are you expecting the situation to continue with the market uncertainty causes, or seeing those eased up in some areas, how do you think that’s going to be following on?

Hugh Taylor: I mean, we, the small number of valuations that we’ve sought since Covid-19 has been underway in the BTR sector basically held up, so we haven’t had any difficulties that have been driven by valuation, we haven’t had difficult conversations with borrowers that have been driven by valuation, and that obviously has not been the case across all housing sectors. So that’s another demonstration of the resilience of the position, or the perceived resilience of it. So, yeah, valuation hasn’t been a difficulty.

I think at the moment most of our borrowers are projecting, they’re not reaching covenant for example, so, it’s not a focus of attention and hence why I would suggest most of the terms that we’ve agreed historically, remain protonate at the moment, it’s just that the overhang terms of just being candid around concerns about the unwinding of the furlough and what that may bring for the sector. I personally doubt that it would be a tsunami but it might actually create pressure on revenue for a period.

Andrew Yates: Now I will just mention for everyone that’s sort of listening in, that if they do want to send through a quick question, I haven’t seen any come through, if anyone wants to send one through on the chat, we can try and pick it up, just got a couple of minutes; but otherwise, going on back to Rajesh, with a view to us now to finish up at 11:30, what would you say some of your messages to people looking at the sector conclude or the way it’s going to be?

Rajesh Shah:  Let’s look at, the bottom line is, four months since lockdown has started, the word resilience really springs to mind, so I sort of mentioned before when collections are at a very strong level, rents themselves really hasn’t dropped, occupancy I’ve mentioned the challenges but actually in the scheme of things it’s very little impact coming through. Most of the operators move to improve the tech platforms, improve customer service proposition, so medium-long term, I think it still remains a very strong outlook for the sector and if anything you look at demographics, specifically in London supply and demand, if people cannot afford to get onto the housing ladder for various different reasons, rental still remains their obvious proposition to come. So I think there is a very strong outlook, but we have a number of months and possibly longer to work our way to what this means at the moment.

Andrew Yates: That’s interesting. Hugh, as a final... if I could just follow up on something you said there Rajesh, quickly, I just have a question that has come through, saying lthough rent collections held up with demand for leases we do see a little bit, how do you think this is going to impact on property prices, generally on the price of properties in the UK?

Rajesh Shah:  I’m not having been involved in the sector four or five years, I’ve seen a detachment between property prices or a sort of individual, you know, home or flat bases verses build-to-rent valuations; and we speak about build-to-rent valuations yields haven’t changed and there’s been no material on that was individual purchases that has been impacted. So I think on that bases actually the build-to-rent sector will remain pretty strong and stable. Short mid-term I can see an impact coming through for an employment furlough and other reasons within a normal property valuation.

Andrew Yates: ...And then back to Hugh, on a sort of closing remark, if you got sort of developers and investors out there who wants to borrow, and you said you’re focusing on relationship banking; what suggestions would you make to someone who’s coming to you who does want to talk to HSBC about borrowing into this sector, are you open to conversations?

Hugh Taylor: Yeah, we are open to conversations for sure; and all I would say is I think that timing is everything Andrew, and I’m not sure that now is the optimal time to be approaching any funder, because it’s like very difficult to price the risk, so that would be my main point. I think to what Rajesh just said, generally speaking it’s like 4.5 million UK households in renting accommodation now and it’s expected that within five years that’s going to go to 7.2 million, this is a sector that, as Rajesh touched on, if you view it through the lens of what’s happened in the U.S. and how big this sector is there, this has a lot of opportunity and a lot of upscale to develop and I think there’s been elements of nervousness about what happens when this spreads out of your Londons, and your Manchesters, and your Birminghams, I think the evidence that we’ve seen is that it takes hold in these regional cities because a top level BTR product is not being seen in those places before and it appeals to people; and I think that the sector has a really strong future. It’s just that it’s a hiatus at the moment and that would need to be taken in context that hiatus within BTR is not as deep, the impact is not as deep presently as they are in other real estate sectors. So, to Rajesh’s point around detachment; I mean if you’re an investor and you’re looking to move into a sector, and you have to deploy a certain percentage of your assets within property, what asset class would you look at?

Andrew Yates: Well, I think I’d be certainly looking at build-to-rent at the moment and it’s nice to end up on a positive note. So, as we’ve gone past 11:30, I’m going to draw things to a close by saying thanks specifically to Hugh and Rajesh for joining us today. Thanks to everyone else who’s dialed in, and I think there is going to be a recording of this available; but please watch out for the next Real Estate Finance team webinar and everyone please have a good summer.

Hugh Taylor: Thank you.

Rajesh Shah: Thank you very much.