Negatively Valuing the Build-to-Rent Premium

You wouldn’t pay more for a vacant multi-unit industrial estate would you – so why do that for residential?

That is the dilemma that residential valuers are being faced with when assessing purpose built residential Build-to-Rent (“BtR”) buildings as historically values have been assessed as a discount to the summation of the individual flats sale prices, reflecting a wholesaler’s profit and costs.

This “cap” on value causes a conflict between BtR developers and funders, as funders will want an efficient and durable BtR product that minimises on-going running costs and depreciation, whereas a developer will be focused on keeping upfront costs to a minimum to ensure that they stay competitive for sites when bidding against the traditional housebuilder.

So should BtR therefore be valued more than the traditional method suggests?

The RICS is alive to this, issuing their “Valuing residential property purpose built for renting” information paper in September 2014. This encouraged valuers to adopt a Discounted Cashflow (“DCF”) approach as part of deriving a valuation. This will take into account more of the lifecycle costs (and benefits) of a BtR development.

That of course is sensible, but ultimately valuers will still need to look at the market comparables as part of this, which goes back to the rent and yield basis for an exit price.

For rental levels, these comparables may be taken from predominately Buy-to-Let flats in the locality. As one of the two factors in deriving value, could this be a fair comparable to take as one big advantages of BtR for the occupier is its ease – which should attract a premium.

That is starting to change however, with evidence starting to be created that shows that rental levels in BtR is tending to be around 5% to 10% ahead of Buy-to-Let rents in the locality.

What does this mean for yields? At the moment a capitalisation rate of 4.5% to 5.0% is not unusual on the net rental income. How much of that has been caused by yields having to be at this level in order to support BtR funders acquisition prices (that have needed to comparable to the housebuilders)? Or is it based on a risk premium that reflects BtR’s lower depreciation, diversified income and inflation hedging characteristics?

It seems to me that both of the above arguments are correct and (1) rents should be at a premium to Buy-to-Lets and (2) yields are also at the right levels when compared to what the appropriate risk premium over the risk free rate should be.

If right, this should allow developers to enhance their specification to deliver the right BtR product for funders whilst still being competitive.

Author: Steven Wright, Palmer Capital