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UK & Ireland BUILD-TO-RENT (BTR) CONSTRUCTION MARKET OVERVIEW Q1 2020
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BUILD-TO-RENT (BTR) CONSTRUCTION MARKET OVERVIEW65F97171-06DC-4E0D-9F75-BF266BFEA98D}BtR...BtR Construction Market Overview BTR CONSTRUCTION DEMAND OVERVIEW UK For UK construction

Mar 27, 2020

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Page 1: BUILD-TO-RENT (BTR) CONSTRUCTION MARKET OVERVIEW65F97171-06DC-4E0D-9F75-BF266BFEA98D}BtR...BtR Construction Market Overview BTR CONSTRUCTION DEMAND OVERVIEW UK For UK construction

UK & Ireland

BUILD-TO-RENT (BTR) CONSTRUCTION MARKET OVERVIEW

Q1 2020

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BtR Construction Market Overview

BTR CONSTRUCTION DEMAND OVERVIEW

UK

For UK construction generally 2019 was very busy, reaching a historically high level of output for new construction work. However, the overall construction new orders pipeline shrunk during 2019 as the housing market stalled and as Brexit uncertainty took its toll. How quickly the resulting gap in workload can be filled depends on the pace at which clients can recommit to investment in 2020.

Although residential new orders in 2019 fell short compared to the previous three years by around 8%, they were still broadly in line with the per annum average since the recovery in 2012. New residential construction output reached over £42bn in 2019, the highest level ever and higher than recorded output in the 2007 peak (ONS). 2020 has heralded increased levels of customer interest and an upturn in investment activity is being reported across the residential sector.

In 2019 there was approximately £2.5bn of investment in the BtR sector (CBRE), predominantly from institutional investors, public and private companies. Much of the investment to date has been domestically sourced but the share of investment from North America, Middle East and Asia is rapidly growing.

The BtR sub-sector outperformed the wider residential construction market in 2019, supported by strong rental growth expectations. UK completions were up by around 50% compared to 2018, adding approximately 10,000 BtR homes in 2019 (BPF), accounting for about 5% of UK-wide residential completions. The NHBC reported an increase in BtR starts of 57% in 2019 compared to 2018.

MAINSTREAM RENTAL GROWTH

EXPECTATIONS

As at Q1 2020 London

UK Regional Cities

DublinIreland Regional Cities

2020 (f) 2.0% 2.0% 4.0% 5.0%

5-year compound (f) 19.8% 13.1% Not

availableNot available

(f) Forecast (Savills and SCSI)

In response to customer demand and good expected yields, 2019 saw the continued shift of BtR activity away from London to the regions with approximately 55% of homes completed in 2019 outside of London (BPF). In London, BtR projects currently account for about 20% of the new residential construction market but Manchester has spearheaded the regional shift and BtR construction currently accounts for roughly half of new residential construction in the city region.

This pivot away from London is extending to Birmingham, Sheffield, Leeds, Liverpool, Edinburgh, Cardiff and other regional cities offering improved investment returns, which are all attracting increasing levels of investment interest in BtR and Co-Living.

“There was a slowdown in capital markets activity in Q4 2019 because of general election uncertainty, particularly the perceived risk of potential rent controls under a Labour government. Rent controls in themselves are not necessarily a problem for the market and tenant protection is very welcome, but uncertainty stemmed from the form potential controls might take.

2020 has heralded a brisk return to investment activity with investors eager to deploy equity in the ‘for rent’ sector. With such little suitable existing stock, forward funding for BtR is becoming more the norm, giving investors control of design as well as superior returns”

–Giles Scott Director – Capital Markets and Transactions

“An increasing number of traditional open market sale developers are opting to forward sell developments as BtR sites to investors. Whilst this model may offer lower overall margins it generates a strong return on capital for developers and speed to market with investors funding the build.”

–Tom Mackenzie Senior Director – Lenders and Investors

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BtR Construction Market Overview

REPUBLIC OF IRELAND

Whilst Brexit-related uncertainty has impacted the Republic of Ireland to an extent, the Irish construction market has seen strong performance since recovery commenced in 2013, growing by over 80%, albeit from a relatively very low base (CSO). This has predominantly been driven by good economic performance and the emerging tech scene spurring private investment as well as a clear pipeline of public sector projects. Overall construction output is expected to grow by 15% to 2022.

The residential sector has outperformed wider construction activity, seeing a 300% increase in new residential construction output since the start of 2014, to reach almost €5bn in 2019 (CSO). Further growth is expected, and the housing challenge is prominent in government policy around shortages of supply, affordability and homelessness.

The BtR sub-sector is hot in Ireland, particularly Dublin. An estimated €2bn of investment has flowed into the sector in 2019, much of it from wider Europe and increasingly from North America. Approximately 3,000 BtR homes were completed in Ireland in 2019. Proportionally, this makes the BtR sub-sector more prominent in Ireland than the UK and places increased pressure on supply chains to meet demand. Whilst Dublin has been a main focal point of investment, Cork, Galway and Limerick are all seeing increasing levels of investment interest in the sector.

“The ‘for rent’ sector continues to dominate transactions in the Irish property investment market. Tax and regulatory disincentives continue to drive buy-to-let landlords from the market and there remains a shortage of ‘for rent’ homes compared to demand. We expect 2020 to see continued high levels of demand in the sub-sector.”

–Sabrina Mackin Client Development Director – Republic of Ireland

“With market sale viability being tested, we have seen an increasing number of our clients wanting to explore the BtR commercial model. Working with local authorities to maximise agility within planning permissions can provide some flexibility at the early stages.”

–Tim Robinson Partner - Commercial Development

“Consistently we hear in the market that viability is a big hurdle when it comes to BtR investment. Our experience tells us that viability can be achieved through adjusting the balance of key levers, to arrive at an attractive investment proposition.”

–Chris Jones Director – Development Advisory

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BtR Construction Market Overview

BTR CONSTRUCTION PIPELINE

Number of BtR homes in planning or construction (000)*

UK London 55

UK Regional Cities 55

Ireland 18

TOTAL 128

(BPF, daft.ie, LIV Consult) *Figures are approximate, subject to change and indicative only

RESIDENTIAL DEVELOPMENT LAND Despite Q4 2019 seeing a great deal of uncertainty, UK residential development land values increased marginally, rising 1 to 1.5% in the year. Constrained availability of suitable sites continues to be cited as a main barrier to development.

For the BtR sub-sector, competition with Build-for-Sale projects in acquiring land continues to be a key challenge. The higher annual rates of return typically achieved with Build-for-Sale can enable it to displace Build-for-Rent projects in the land acquisition stage.

To compete, innovative approaches are needed in the BtR sub-sector to drive return on equity for developers. As such, smart design, mixed tenure schemes and relatively higher density can help. Joint ventures between the private and public sectors involving provision of land in exchange for a de-risked interest in a long-term income generating asset and delivery of broader social objectives have also been proven in the market.

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BtR Construction Market Overview

BTR CONSTRUCTION TENDER PRICE FORECAST

Our view is that construction tender price inflation for residential projects currently broadly aligns with the wider market. However, our view tracks factors that are likely to result in a divergence in inflation expectations from other sectors, for example demand and supply balance for key packages that proportionally have more influence on residential construction such as drylining and others in fit out.

The below table outlines our anticipated construction tender price growth in the BtR sub-sector in the year to Q4. It is important to note that the below represents the expected average across a range of schemes. It is important to take project-specific factors into account when forming a view on tender price inflation at project level.

(e) Estimate (f) Forecast London UK

Regional Cities Dublin Ireland Regional Cities

2019 (e) 1.0% 2.0% 6.0% 6.0%

2020 (f) 1.0% 2.0% 5.0% 5.0%

2021 (f) 3.0% 3.0% 4.0% 4.0%

2022 (f) 5.0% 5.0% 4.0% 4.0%

2023 (f) 5.0% 5.0% 4.0% 4.0%

(Arcadis)

BTR INDICATIVE CONSTRUCTION COSTSIndicative only based on gross construction cost for BtR apartments, for a variety of scales, designs, specifications, procurement routes and locations. Project-specific factors are obviously key to forming a view on likely constructions costs. Clients considering investing in BtR developments should engage consultants experienced in the sub-sector.

Indicative figures are given on a per m² NIA basis in local currency.

Per m² as at Q1 2020 London UK Regional Cities Dublin Ireland

Regional Cities

Range £2700 - 5000 £1700 - 4000 €2200 - 2700 €2200 - 2700

Average £3850 £2850 €2450 €2450

(Arcadis)

THE FUTURE HOMES STANDARDThe UK Future Homes Standard consultation was launched in 2019 covering proposed changes to Part L (Conservation of fuel and power) and Part F (Ventilation) of the building regulations for new homes.

The standard is aimed at dramatically reducing carbon emissions associated with the construction and operation of new homes. Interim changes designed to deliver a 20 to 33% reduction in emissions, depending on the preferred option, will be introduced in 2020 with fuller implementation of a more far-reaching standard by 2025.

End customers are increasingly environmentally conscious and enhanced environmental performance is and will increasingly be a driver of customer choice, a key focus in the BtR sub-sector. Additionally, some of the standards being proposed may drive whole life savings for BtR operators in due course.

However, achieving the build quality implied by the new standards may be a challenge. There may also be supplier capacity constraints associated with key material specification upgrades, for example triple glazing. The likely introduction of measures to disincentivise electric heating and all-electric buildings could also present challenges for BtR clients that will need to be considered at the earliest stages of project lifecycle.

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BtR Construction Market Overview

Many organisations will not differentiate their experience in BtR projects from experience in other residential asset classes. The involvement of delivery partners and main contractors that truly understand the BtR product can be beneficial because succeeding in the BtR market can demand different approaches compared to the more dominant ‘for sale’ sector. A heightened focus on end-customer experience and whole life operation are examples of critical aspects that may contribute to performance of BtR investments. Working with organisations that understand the full range of potential key success factors in BtR, can help make projects more viable and successful.

UK

As a result of Brexit-related uncertainty, and particularly the impact felt from this in the commercial sectors, some capacity returned to parts of the main contracting market in 2019, in London for example. As a result, now may be a good time for clients to procure projects to secure capacity.

That said, the market is still relatively busy and decisions made by some contractors back in 2018 to reduce turnover targets for 2019 and 2020 rather than risk engaging in aggressive price competition have played out with operations rationalised where necessary.

Financial fragility in the supply chain remains a key issue. This year’s ranking by Construction News saw the top 10 main contractors record an average margin of 1.4% and the top 100 an average margin of 2.1%.

In a random sampling of 24 development partners and main contractors operating in the BtR sub-sector, we found the average margin was 3.8% last year, an over 40% improvement on the average margin the previous year. Whilst average margins have shown improvement, insolvencies in the industry are still at concerning levels. According to the Insolvency Service, there were 6814 business failures in UK construction in 2019, a 6.4% rise on 2018.

The money owed to unsecured creditors such as subcontractors, unlikely to be recovered, runs into the hundreds of millions, only adding to financial fragility across the industry. The precarious state of contractors’ finances can stoke risk aversion and can restrict the supply chain’s ability to reduce or hold pricing. However, this is not a dominant consideration in our tender price forecast. The main price drivers that we have allowed for in our tender price forecast are increasing labour and material costs and perhaps some recovery in margin which is related to increasing bidding activity.

Brexit-related risks associated with the trade deal negotiations, the impacts of which will not be clear until 2021, could lead to the supply chain’s attitude to risk hardening in 2020, which can manifest as higher pricing. That said, in 2019 we saw many contractors happily bidding without any protection against key Brexit risks, suggesting the balance for many constructors is more in favour of risk-seeking.

CONSTRUCTION SUPPLY-SIDE OVERVIEW

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BtR Construction Market Overview

REPUBLIC OF IRELAND

Capacity constraints are worse in Ireland than in the UK, highlighted by the very high levels of construction tender price inflation and widely reported issues securing suppliers for projects. The level of activity signifies that much of the supply chain is ‘running hot’ meaning good management and assurance of projects is key as ever to ensuring quality delivery to time and cost.

Despite the high levels of construction tender price inflation, contractor margins are generally still relatively low single digits, due to the substantial rate of input cost inflation. Significant increases in labour costs are a key contributing factor to this and securing the right skills a continuous challenge.

Whilst still a concern, financial poor health of the Irish supply chain appears to be less pronounced than in the UK. Insolvencies in the construction sector in 2019 were lower than in 2018, suggesting improved financial performance in the sector.

“Integrating design and construction with future operational management is crucial to success in BtR. Working with construction consultants and supply chain that fully understand this should be a key aim for construction clients in the BtR sub-sector and reliable assessment of this is an important part of the tender process.”

–Richard Jones Partner – Residential

“Providing an exceptional experience for end-customers is central to the success of BtR schemes. Placing this at the heart of the construction delivery model, for example by ensuring the objectives and measurement of all suppliers align with and drive towards the end-customer experience, is a key lever for ultimately maximising success and investment returns.”

–Will Waller Director – Build-to-Rent Market Leader for Arcadis

“In Ireland, two of the biggest challenges we are seeing in the BtR sub-sector is access to and the cost of suitable sites and growth in construction costs. Rapid optioneering of schemes, for example using our parametric design tool, is increasingly in demand and construction clients are increasingly speaking with us about the potential speed-to-market and other benefits that modern methods of construction, such as modular, could deliver for their schemes.”

–Joe Bermingham, Director – Republic of Ireland

“The BtR Market has started to mature as the product become a significant part of our annual construction output. Developments are now being designed for BtR rather than designed as a market sale product to protect the exit strategy which opens the opportunity for more standardisation. We are seeing increased interest from developers to explore modular construction and the benefits to deliver high quality developments at speed at competitive costs.”

–Matt Howell-Jones Partner – Residential

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Will WallerDirector - Build-to-Rent Market Leader

E. [email protected]

James KnightPartner – Residential Sector Leader

E. [email protected]

Andy MatthewsPartner - Commercial Development Sector Leader

E. [email protected]

Ross GissanePartner - Lenders and Investors Sector Leader

E. [email protected]

Disclaimer This market overview report is based on market perceptions and research carried out by Arcadis, as a design and consultancy firm for natural and built assets. It is intended for educational purposes only and should not be construed or otherwise relied upon as investment, financial or delivery advice. This document may contain forward-looking statements. Forward-looking statements are those that predict or describe future events or trends and that do not relate solely to historical matters. Actual results could and likely will differ, sometimes materially, from those projected or anticipated. Arcadis is not undertaking any obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise. You should not take any statements regarding past trends as a representation that those trends or activities will continue in the future. Accordingly, you should not put undue reliance on these statements. The data in this document is not guaranteed as to its accuracy and does not purport to be complete. Arcadis accepts no liability for loss arising from the use of the material presented in this report. This document should not be relied on in substitution for the exercise of independent judgment.

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Arcadis. Improving quality of life.

Sources:• Arcadis• British Property Federation (BPF)• CBRE• Central Statistics Office (CSO)• Construction News• Daft.ie/LIV Consult• Ministry of Housing, Communities & Local Government (MHCLG)• NHBC• Office for National Statistics (ONS)• Savills• Society of Chartered Surveyors Ireland (SCSI)• The Insolvency Service

www.arcadis.com/uk

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