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Property investors do not want house builders to move into the rental sector

Qualitative interviews with specialist house builder analysts and fund managers suggests that the lure of 20% returns if the market recovers outweighs the stability that rental, as a stream of income, could offer. The reduced risk and more consistent cash flow do not outweigh what investors expect to be significantly lower returns.

‘Investors see house builders as a high risk, high yield stock. They jump in with both feet when times are good. The volatility seen over the last few years in house builder shares offers investors opportunities to make significant gains if their timing is correct,’ said David Powell, Head of Residential Development at law firm Osborne Clarke.

‘If house builders entered the rental market, the perception is that these opportunities would diminish. You can see their dilemma. It's like being offered a salad when you're in a cake shop,’ he added.

House builders are at the coalface of the economic cycle as the availability of land, capital and mortgages are all key factors in performance and thus their attractiveness to investors. To tackle this issue, some house builders are looking to rental in specific markets as an obvious extension to their core business, and a means to hedge against a downturn.
What form the market will take when it does return is also a major consideration for the industry. If home ownership is less accessible or attractive in the future for a larger number of people, this will inevitably drive house builders to look at how they grow their business to take advantage of rental growth.
‘There appears to be an entrenched view amongst investors that a return to high returns is inevitable. This is not a certainty by any stretch. At the moment, the rental market is growing with mortgage availability tight. If this becomes a longer term structural change to the market, investors need to accommodate a strategic move by house builders into this market,’ explained Powell.

If House builders do pursue a move into rental, there are several aspects that concern analysts and fund managers of which they should be aware. These are finance, long term outlook and joint ventures and acquisitions.

Analysts are concerned that house builders lack the finance to move into rental. House builders need to show how such a move could be financed. Analysts are concerned that the opportunities for build and sell in a recovering market could be missed if finance and focus is elsewhere.
They also point out that house builders would need to tackle the perception that this is likely a move to offload stock they can't sell. The location of any move into rental is critical and should match rental demand. A move into rental needs to be strategic and long term.
And they say that rental markets are relatively difficult to predict. They are highly localised and require expert knowledge. Analysts would therefore favour a joint venture with a third party with the relevant management skills.

‘House builders are rightly focused on the long term strategic direction of their businesses; the investment community are rightly focused on getting the best returns. As house builders seek to address the issues facing their industry, they may need to look at how they re-position the industry with investors as a lower risk investment opportunity focused on selling and renting properties. This could take some time,’ said Powell.