Forward funding investors are taking BTR into their own hands

Winckworth Sherwood’s Christopher Brigstocke reflects on the popularity of the Build to Rent sector among investors.

Christopher Brigstocke, Partner at Winckworth Sherwood | BTR News
Christopher Brigstocke, Partner at Winckworth Sherwood.

This year has started with yet another wave of interest in investing in Build to Rent in the UK, with Cushman & Wakefield estimating that investors are targeting £8.1bn at the sector.

By Christopher Brigstocke, Partner, Winckworth Sherwood

This is hardly a surprise. Rental demand across the UK remains at its highest level in decades. High interest rates, perpetually rising house prices, and the chronic undersupply of homes make this unlikely to change anytime soon. Within the context of these housing dynamics, Build to Rent is only likely to grow in its attractiveness to investors.

While widely deemed to be a sensible investment, the more pressing issue for funds has been getting hold of stock. It’s a market still very much in its infancy in the UK, and while the demand is high, the current lack of supply has limited the ability for units to be traded.

With investors hungry to reap the benefits that this asset class can provide, they are increasingly taking matters into their own hands – entering forward funding arrangements to grow their portfolios.

To forward purchase or forward fund?

Forwarding funding development appears to be stacking up for investors compared to the alternative strategy, which is for forward purchase of new – yet to be developed – stock.

In a forward purchase agreement, investors agree a set a price with developers in advance of construction, which is then paid upon completion of the development.

On paper this is an attractive arrangement for investors. Forward purchasing requires minimal capital outlay, and with the transfer of ownership only taking place upon completion of the works, they are shieled from the construction risk and financial pressures on the housebuilder. It also provides price certainty, protecting them from market fluctuations and potential cost increases.

However, despite the minimal upfront risk involved, appetite for this type of funding agreement is shrinking. Cushman & Wakefield’s survey finds that only 19% of Britain’s leading Build to Rent investors call this their preferred type of deal structure for this year. That’s likely due in part to reluctance within the developer community to enter into these types of agreements. Challenging economic conditions, instability in the construction supply chain and volatile interest rates have in many cases constrained their ability to fund their own schemes outright and take on the risk that a forward purchase arrangement typically lands at their door. 

Funds are therefore having to play an even more active role in the development process to deliver the stock they demand. This has brought forward funding to the fore. In this arrangement, investors fund the land purchase and construction in staged payments throughout the construction process, sharing the profits with the developer at the end. This shifts the financing risk from the developer to the investor which is inherently better placed to manage it.

Despite the greater upfront financial risk, forward funding gives investors greater overall control. Providing investment during the development process gives them more say over construction quality and timelines. Against a backdrop of tightening regulation for lending when it comes to environmental performance, it also gives the investor greater visibility on the asset and how resilient it is likely to prove in the long-term within their portfolio. There are tax benefits, too. Investors have the potential to confine the stamp duty to that payable on the site value, rather than that of the end product.

Greater risk means a greater emphasis on terms

While greater risk may well bring greater reward, it also calls for a greater scrutiny on contracts; ensuring they are well drafted so that developers deliver units on time and to the agreed standard.

Forward funding arrangements are not immune from the wider challenges impacting the construction market. As with any project, there can be the potential for cost overruns, and with investors providing capital up front, they will want to make sure they can keep these under control. Funding instalments should therefore be linked to the advancements of the works, ensuring developers stay within budget for each stage of the construction process.

A well drafted forward funding agreement will typically contain a maximum financial commitment limit for the investor and will place the burden of meeting cost overruns on the developer. Accurate monitoring processes are therefore imperative to ensure contingency thresholds are not exceeded and cost projections are kept under continuous review.

Forward structures are here to stay

With the stock of Build to Rent units low and the economy unpredictable, forward funding looks likely to remain a popular option for investors looking to grow their portfolios this year.

While steadying inflation may encourage more forward purchasing arrangements in the future, current economic forecasts suggest it’s unlikely we will reach a low interest rate environment for some time meaning funds will need to continue to play a more hands on role in the development of Build to Rent schemes.

Whatever agreement investors opt for, it’s important that contracts are carefully considered to ensure projects are completed on time, on budget, and free from defects.