Download THE EVOLVING RESIDENTIAL GROUND RENT MARKET

THE EVOLVING RESIDENTIAL
GROUND RENT MARKET
CBRE | SPRING 2013
THE EVOLVING RESIDENTIAL GROUND RENT MARKET
INTRODUCTION
The ground rent market has undergone significant changes over
Ground rents fall under the umbrella of a growing group of fixed-
the last two years. This period has been characterised by a distinct
income property investments, including income strips. The key
change of ownership. There has been a substantial strengthening
attraction of these assets is that they provide a level of income which
of the market resulting in a rebasing of pricing.
hedges against inflation and they allow a degree of wealth
preservation.
Residential ground rents have attracted the attention of many of the
largest institutions and property funds. There are still more investors,
This report focuses on the long dated ground rent sector, provides
such as fund managers and institutions, with an appetite for exposure
an update on the market, and outlines our opinion on current issues
to the residential ground rent market and are seeking opportunities
facing the sector.
to enter the sector.
Ground Rents Income Fund plc - One Park West, Liverpool
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CBRE | THE EVOLVING RESIDENTIAL GROUND RENT MARKET
THE EVOLVING RESIDENTIAL GROUND RENT MARKET
THE BASICS
A MODERN HOUSEBUILDER LEASE
WHAT ARE GROUND RENTS?
Ground rents are a product of the freehold/leasehold structure in
English law. The ground rent is an annual payment to the landlord
in consideration of the grant of a long lease, with the landlord
CLAUSE
EXAMPLE TERMS
Term
125 years
Ground Rent
£250 per annum
Review Mechanism
10 yearly RPI indexation
Repairs and Maintenance
Management Company,
of which lessee is a member
Insurance
Management Company,
of which lessee is a member
ultimately benefitting from the reversion at expiry.
Long leases are drafted by housebuilders on disposal of flats,
or in some cases houses. Over the past 30 years housebuilders
have become increasingly aware of the investment value that can be
created by drafting their leases in a manner that secures a ringfenced income stream for future freehold owners. This is particularly
the case over the last 10 to 15 years as leases have been optimised
in terms of the rent review clauses, notice fees and other provisions,
to maximise freehold sales receipts for the developer.
THE INVESTMENT APPEAL
Longevity of Income
Modern residential long leases provide income streams
of in excess of 125 years. Such terms are far in excess
of those available in the wider property sector and
financial markets.
Income Security
Ground rents are heavily collateralised. The underlying
property value is often 30 to 50 times the value of the
ground rent investment.
PERCEIVED RISKS
Disaggregation
The investor’s ownership is spread over thousands
of units with the resultant management, legal and
cost implications.
Management
Management of large ground rent portfolios is complex.
Significant IT expenditure is necessary to optimally
manage portfolios and maximise returns.
There is arguably a shortage of independent agents
who are able to undertake portfolio administration
such as ground rent collection.
Unlike traditional residential and commercial assets the
return generated from the investment is not solely derived
from rental income. ‘Soft income’ can be generated from
notice fees, insurance premium commissions, service
charge management and enfranchisement premiums.
Portfolio Size
Large portfolios are necessary to create the economies
of scale which can generate optimal returns.
Creating a portfolio of scale is both costly and
can take a significant amount of time.
Minimal gross to net income deductions in comparison to
the commercial and residential property sectors. The main
cost involved in holding ground rent investments is the
cost of ground rent collection and administering notices.
Reputational Risk
Minimal Income
Erosion
The sheer number of lessees an investor has to interact
with means that investors will be exposed to reputational
risk, often regardless of how successful they are operating
as a freeholder.
Lack of Volatility
Ground rent investments have historically remained
relatively insulated from the market volatility that has
affected both the residential and commercial investment
markets over the last few years. Ground rents have been
viewed as a safe haven by investors.
The Right
of First Refusal
Lessees must be offered the right of first refusal of the
freehold/headlease before it is sold in the open market.
Premiums
Residential ground rents can often generate significant
capital sums from lease extensions and enfranchisement
premiums, albeit in some cases with a reduction
in ground rent receipts due to statutory provisions.
Lease Extensions
and Enfranchisement
A leaseholder may seek to extend, or as a group
of leaseholders collectively enfranchise, their leases.
The freeholder can therefore potentially lose the
ground rent income, albeit in return for a capital sum.
Liability Matching
Provisions
Ancillary Income
The review provisions of ground rents are considered
attractive, often being based on indexation to RPI
or a fixed uplift as opposed to reviews to market rents.
Such mechanisms enable investors to match liabilities.
CBRE | THE EVOLVING RESIDENTIAL GROUND RENT MARKET
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THE EVOLVING RESIDENTIAL GROUND RENT MARKET
OWNERSHIP
THE MARKET
CHANGES IN OWNERSHIP TRENDS
DRAMATIC PRICE INCREASES
There has been a distinct change of ownership structure within the
The market has experienced dramatic price increases over the last
residential ground rent market. Over the past few years ground rents
two years. From our own analysis and benchmarking, gross yields
have attracted the attention of many of the largest institutions and
on long dated residential ground rent investments have strengthened
property funds. These investors view the returns as highly attractive
significantly since 2010, with a move of approximately 125 basis
against the risk profile of the asset, and ahead of those available
points reflecting a multiplier shift of approximately four Years
from gilts and bonds. A number of these investors have made the
Purchase (YP).
leap into the sector, either directly investing or indirectly investing
within funds. For example, Aviva Investors and Brooks Macdonald
Ground Rent Investment
(adviser to Ground Rents Income Fund plc) are among a new breed
7.00%
months creating substantial residential ground rent funds.
Yield
4.00%
3.00%
Historically, the ground rent market has been considered a relatively
2012 - H2
2012 - H1
2011 - H2
2011 - H1
2010 - H2
2010 - H1
2009 - H2
2.00%
2007 - H2
24 months.
5.00%
2009 - H1
market and we estimate have acquired over 75,000 units in the last
6.00%
2008 - H1
A handful of new investors have dominated purchasing within the
Gilt 4.25% Treasury 2032
8.00%
of investors who have been particularly active over the last 24
75,000 UNITS BOUGHT IN THE LAST 24 MONTHS
Commercial Property
9.00%
Year
discrete and closed marketplace, the preserve of a limited number
of investors. The market has evolved from the traditional landed
A significant number of investors with substantial funds are chasing
estates and family trusts through to debt securitised vehicles and
a finite amount of available ground rent stock. Many of these
to the current institutional landscape.
investors are not reliant on debt to fund purchases and can execute
transactions swiftly. These new 100% equity purchasers dominate
bidding and with ambitious growth targets they need to bid
aggressively to acquire stock. Existing investors and geared
purchasers are still active in the market but to a lesser degree; they
Institutions
and Funds
Leveraged
Investors
often have to rely on existing relationships with housebuilders,
aggregating smaller purchases, or sourcing off-market
opportunities.
Private Investors
and Family Trusts
The characteristics of each ground rent investment can vary, but the
Landed
Estates
principal value driver for large long dated transactions (£500,000
plus) is the rent review mechanism. RPI-linked review mechanisms
have experienced the biggest price escalations, particularly those
with review frequencies of 15 years or less. The characteristics
of these review mechanisms meet the funds’ investment criteria
enabling them to match their own investor’s liabilities.
With index-linked gilt yields at historic lows
we believe both residential and commercial
ground rents can offer secure, long-term,
inflation linked income streams.
Neil Gardiner, Aviva Investors
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CBRE | THE EVOLVING RESIDENTIAL GROUND RENT MARKET
5 YEARLY RPI VALUE SHIFT
2010
2013
19YP
26YP
£50,000 pa = £950,000
£50,000 pa = £1,300,000
THE EVOLVING RESIDENTIAL GROUND RENT MARKET
In our fund’s 20 year experience , we now see more money than ever seeking to buy a currently
reduced number of ground rents created at an historical low point in the building cycle.
Nigel Ashfield, Freehold Income Authorised Fund, Time Investments
PRICING SNAPSHOT
All review types, whether they be RPI linked, fixed multiple (such
as doubling), fixed increments (such as of the initial ground rent)
REVIEW MECHANISM
MULTIPLIER (YP)
GROSS YIELD
or capital value linked, have seen pricing increases.
A limited number of portfolios of over £2 million are available
each year and therefore attract the most aggressive bidding. Newer
investors prefer larger lot sizes due to the number of units it allows
5 yearly RPI
26
3.8%
10 yearly RPI
23
4.3%
25 yearly RPI
19
5.3%
20 year Fixed Multiple (Doubling)
19
5.3%
25 year Fixed Multiple (Doubling)
18
5.6%
25 yearly Capital Value
17
5.9%
them to acquire in one transaction and the consequent savings
in transactional costs. Consequently it is common for large lot
sizes to transact for multipliers in excess of 20 YP (5% gross yield).
WEAK HOUSEBUILDING ANTAGONISES
DEMAND SUPPLY IMBALANCE
The relatively low level of housebuilding over the last few
years serves to compound the supply and demand imbalance.
Developers’ expectations on disposal of their ground rent interests
are also changing. Housebuilders have become more aware of the
benefits of structuring leases in an attractive manner to increase
the value of their holdings and seek to maximise sale receipts
on disposal.
Housebuilders are producing fewer
leasehold units than pre-2007, so the
supply of stock is tighter and is pushing
the multiples upward.
Roberta Anderson,
Dorchester REAM
Aviva Investors - Sailacre House, Greenwich
CBRE | THE EVOLVING RESIDENTIAL GROUND RENT MARKET
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THE EVOLVING RESIDENTIAL GROUND RENT MARKET
MARKET TOPICS
NEW INVESTORS
There are still further investors, such as fund managers and
institutions, with an appetite for exposure to the residential ground
rent market. The challenge for these new investors is what strategy
to employ to gain entry to the sector.
Traditionally investors have sought to acquire small portfolios
over a longer period of time directly from housebuilders or existing
investors. The advantages of such an approach include the
avoidance of having to bid overly aggressively to secure stock.
However, such a strategy takes a significant amount of time
to employ and build scale.
Larger investors have sought to target portfolios in excess
of £200,000, ideally with a focus on acquiring portfolios of the
Aviva Investors - Toronto Building, Canada Water
scale of a few million pounds. Such a strategy allows the investor
to gain scale quickly, limits transaction costs and potentially includes
MANAGEMENT
debt from first purchase. The potential drawbacks include securing
One of the major challenges for the residential ground rent sector
a pipeline of potential portfolio acquisitions and the potential
surrounds the management of portfolios. The evolving ownership
strong pricing of large portfolios.
structure demands greater accountability and transparency from
investors. Governances and processes need to be ensured.
We envisage consolidation within the sector through mergers
From an institutional investment perspective there remains a lack
and acquisitions. The benefits of such a strategy include:
of wholly independent rental collection agents and managers.
n
the ability to deliver scale immediately,
n
access to mature portfolios including a mixture of review
patterns and staggered rent review uplifts,
n
proven track record in terms of level of income generation
and gross to net ratio.
The main obstacle to such transactions is vendors’ pricing
expectations. Likely future investors include pension funds,
insurance companies and sovereign wealth funds.
As is well known, the
management is much more
hands on. This is an area
where we will be bringing
our more institutional ethical
approach as well as enhancing
transparency.
Charles Crowe,
Pramerica Real Estate Investors
The traditional ground rent market is limited by both the quantum of stock made available to
purchase and the quality of management to maintain the investments at a property and asset
management level – both key to institutional investors.
Neil Gardiner, Aviva Investors
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CBRE | THE EVOLVING RESIDENTIAL GROUND RENT MARKET
THE EVOLVING RESIDENTIAL GROUND RENT MARKET
ANCILLARY INCOME
The benefit from a housebuilder’s perspective is a secured capital
There is a reducing focus on ancillary income which can
sum to boost cash flow. For an investor it provides a pipeline of
be generated from activities associated with long leases such
potential stock and can be used to enlarge housebuilder portfolio
as notice fees, insurance premium commissions, management fees
sales. However, there are potential liabilities from the investor’s
and other fees. This change of emphasis is being both investor and
perspective as they must be sure of the covenant strength of the
housebuilder driven with recognition of the potential reputational
housebuilder prior to entering into a forward purchase transaction.
risk involved in generating from certain types of ancillary income.
These agreements are being widely utilised within the ground rent
Housebuilders are now more than often drafting leases with
market. Recently this model has been replicated in the affordable
lessees as a member of the Management Company. Newer
housing sector. A modified version has been employed to provide
investors are regularly outsourcing landlord obligations
much larger capital sums to fund affordable housing developments.
to large independent agents.
FORWARD PURCHASE AGREEMENTS
A forward purchase agreement is a contract between investor and
housebuilder to acquire a scheme before the individual units have
been sold off on long leases. Such agreements are often drafted
with the housebuilder paying the ground rent for unsold units until
they are disposed of. If agreed before 50% of the units are sold,
this can negate the requirement to offer the freehold interest to the
lessees in the first instance on a subsequent sale of the ground rent
holding. Such agreements can often be in place as construction
is ongoing or even prior to it commencing.
One of the largest barriers to further
institutional investment is that
ground rents are challenging to
manage and administer without
significant scale, systems and well
thought out procedures to make
sure that the income is collected
correctly, in accordance with the
relevant legislation and also the
terms of the lease.
James Agar,
Brooks Macdonald
Ground Rents Income Fund plc - Clapham One, Clapham
CBRE | THE EVOLVING RESIDENTIAL GROUND RENT MARKET
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THE EVOLVING RESIDENTIAL GROUND RENT MARKET
CASE STUDY – FREEHOLD INCOME AUTHORISED FUND, £160M GROUND RENT FUND
Orchard Leaze is a development that was acquired from BDW Trading Bristol (a Barratt Homes company) in 2012.
The deal was agreed at the early stages of development on the basis of a forward purchase whereby a large percentage
of the price was paid at exchange of contracts (circa 60%) and the remainder was paid at completion once all the units
were occupied. The acquisition was beneficial to both parties. The developer had the comfort of securing a purchaser
at the initial stages of the development and received a majority percentage of the Freehold sale price. Furthermore
once the site was fully built and occupied they were able to complete on the Freehold sale alleviating the need to serve
section 5 notices. The purchaser had the benefit of a secured purchase and received the total ground rent income from
the developer through to completion.
Nigel Ashfield, Time Investments
Freehold Income Authorised Fund
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CBRE | THE EVOLVING RESIDENTIAL GROUND RENT MARKET
THE EVOLVING RESIDENTIAL GROUND RENT MARKET
THE FUTURE
OUTLOOK
Following a period of strengthening in the ground rent investment
There may be some risk of downward movements in value should
market pricing has been rebased. We envisage current market levels
interest rates and gilt yields begin to increase but we believe there
will become the market norm in the long term.
will not be major pricing readjustments. With more money flowing
into the sector and significant capital to be exhausted we envisage
In a number of cases funds/investors have been diverting investment
the market remaining buoyant for the foreseeable future.
away from a gilts or bonds allocation to residential ground rents.
This is in addition to monies diverted away from property
The market has rebased itself due to the evolution of investors within
allocations. The returns currently offered from residential ground
the market, and these investors are acquiring investments to meet
rents are considered by investors to be significantly in excess
long term obligations.
of those available from gilts or bonds.
In my opinion there is
currently very little formal
‘asset allocation’ to ground
rents from institutional
investors, however the
underlying, secure dynamics
of the instruments and their
appeal in relation to indexlinked income will continue to
make ground rents attractive.
This has led a number of funds benchmarking against gilts
or bonds. However, a linkage between residential ground rents
with gilts and bonds could see a reverse in the price increasing
experienced over the last two years if there were to be a rise
in interest rates and gilt yields. It could also see a number
of the newer investors potentially divesting their holdings.
James Agar,
Brooks Macdonald
We think going forward it is
important that investors have
access to a very large pool of
capital, an established and
experienced legal team, an
ability to hit strict deadlines and
a willingness to be flexible and
innovative.
In a low gilt yield environment
it is likely that investors will
continue to chase a return
premium by investing in illiquid
assets such as ground rents.
Neil Gardiner,
Aviva Investors
Charles Crowe,
Pramerica Real Estate Investors
SUMMARY
n
n
There has been a distinct change of ownership structure within
n
Following a period of strengthening in the ground rent investment
the market. Over the past few years ground rents have attracted
market pricing has been rebased. We envisage current market
the attention of many of the largest institutions and property funds.
levels will become the market norm in the long term.
The market has experienced dramatic price increases over the last
two years.
n
There are still more investors, such as fund managers and
institutions, with an appetite for exposure to the residential
ground rent market.
CBRE | THE EVOLVING RESIDENTIAL GROUND RENT MARKET
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THE EVOLVING RESIDENTIAL GROUND RENT MARKET
CONTACTS
CBRE provides valuation, advisory, and agency services, as well as debt financing and equity advice, in both the residential ground
rent investment market and wider fixed income property asset class.
For further information please contact:
James Castle
Jane Asquith
Associate Director
Director
Valuation and Advisory Services - Residential
Valuation and Advisory Services
e: [email protected]
e:[email protected]
t: 020 7182 2731
t: 020 7182 2242
CBRE DISCLAIMER 2013
CBRE Limited confirms that information contained herein, including projections,
The snapshot of pricing is based on our opinion of multipliers in the current market
has been obtained from sources believed to be reliable. While we do not doubt their
as at Q1 2013. The multipliers assume freehold, good quality well located town centre
accuracy, we have not verified them and make no guarantee, warranty or representation
schemes with a lot size of over £400,000, new leases with 125 plus year terms, ground
about them. It is your responsibility to confirm independently their accuracy and
rent per unit of £250 per annum, landlord retains insurance rights with management
completeness. This information is presented exclusively for use by CBRE clients and
obligations falling to a management company, “normalised” notice fee provisions,
professionals and all rights to the material are reserved and cannot be reproduced
no rental or service charge arrears.
without prior written permission of CBRE.
The focus of this paper is long dated residential ground rent investments. i.e. those
with over 90 years unexpired. These are generally transacted on a multiplier (known
as YP (Years Purchase) which is equates to a gross yield) of the current annual ground
rent income.
and do not constitute CBRE Limited’s view or opinion.
CBRE would like to thank Aviva Investors, Time Investments, Ground Rents Income Fund
plc, Brooks Macdonald, Pramerica Real Estate Investors and Dorchester REAM for their
contribution to the paper. More specifically CBRE is grateful to the following for their
There is no widely accepted index or benchmark within the ground rent sector. This
input; Neil Gardiner, Nigel Ashfield, James Agar, Charles Crowe and Roberta
stems from the relative size of the market as well as the lack of transparency. Portfolios
Anderson.
generally trade principal to principal with details of the transaction rarely reaching the
CBRE
wider market. Each portfolio transaction has different characteristics in terms of units
within the portfolio and the long leases which these are subject to. The graph displaying
a comparison between long dated residential ground rent investments, UK gilts and
commercial property equivalent yields is for illustrative purposes only. The long dated
residential ground rent investment yields are based on comparable sales evidence
collated, transactions we have been involved with directly and our interpretation
of the movement in market multipliers. The UK gilt yield is taken from the UK Debt
Management Office and is based on redemption yields. The commercial property
yield is from the CBRE index and is an all equivalent property yield.
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The comments provided by investors within this paper are their opinion alone
CBRE | THE EVOLVING RESIDENTIAL GROUND RENT MARKET
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