Adrian Jones, lead portfolio manager Infrastructure Debt and Home Equity at Allianz Global Investors speaks to Room151 about the group’s Home Equity Income strategy and opportunities of gradual home ownership in a rising rate environment.
Adrian Jones, Allianz GI
What is gradual home ownership?
The idea is very simple. We find a property that the customer wants to live in and in which the investors are likely to want to invest. The customer must contribute at least 5% of the purchase cost in cash and the investors invest whatever else is needed. The customer pays rent on the investors’ share pro rata. Every single property is owned by its own limited partnership and the members of that partnership are the person who lives there and the investors. Customers have the option to gradually own more of the property by buying little bits of the partnership back from the investors. During the period of co-ownership, other than the rent increasing with inflation, none of the renting arrangements can be changed without customer consent. There is no debt or any sort of refinancing risk, the arrangement is a co-investment between the investors and the tenants.
By requiring customers to invest a significant amount of capital in the partnership with the investors, we create a much stronger alignment of interests than in normal private property letting arrangements. The people who acquire control of these properties behave like owners. We have examples of people who installed new kitchens at their own expense. While 5% doesn’t sound like a lot as a proportion of cost, in absolute monetary terms for many customers, this represents their lifetime savings.
What do institutional investors get out of it?
Investors achieve an alignment of economic interests, a true partnership with tenants, rather than an adversarial relationship. That cuts across a lot of risk factors, from the potential for arrears and defaults to reputational risks which are substantially mitigated.
We have been doing this for a couple of years now, so this is not just a theory, we can point to how people behave in practice, not just when times are good and they are putting in a new kitchen, we’ve had self-employed people who had problems with their businesses. They have come to us and have organised restructuring without the investors ever becoming exposed to any losses.
People are hugely incentivised to do what their parents did. They don’t want to move property every 22 months, they want to put down roots, they want to get a stake in the economy because ultimately house prices do grow with the economy. This is creating an opportunity for our investors to benefit economically from rising property prices without the reputational risk and whilst also doing some social good.
Where does GHO sit in the typical property portfolio?
It will sit somewhere between the private rented sector and social housing. In terms of risk and reward, we are not taking the development risk, so we’re not getting the spectacular gains that you might get if you pick the next go-to area. But we’re not exposed to the risks that come with that either.
On the flipside, we’re also not taking on the risks that come with social housing, where a lot of the schemes are just providing off balance sheet financing to local authorities and putting all the maintenance risk back with them. Here, our investors are responsible for maintenance but in partnership with the people who live there.
In terms of numbers, right now inflation is clearly very high, so returns are probably higher but over the longer-term, you could expect 6-8 % IRR. We’re measuring these things over a ten-year period, even if you have 14 months of 12% RPI, over the longer term these things do have a habit of averaging out.
It is closed-ended because it had never been done before, so we thought the best thing we could do was to be clear with people about liquidity: this strategy is not able to guarantee liquidity yet, it is a 10-15 year investment, a classic private markets limited partnership. It should automatically redeem between the years 10 and 12 but we have put a hard stop on it after 15 years after which we will just seek to liquidate any remaining units.
How is the strategy benchmarked?
We look at the performance of other property strategies and most of them will be reporting a target of 6-8% based on an assumption of underlying asset price growth of c.4%. A lot of property investing is investing in a factor (general property price inflation) beyond the control of the investors. You are investing in the biggest part of the UK economy. Individual managers won’t drive the House Price Index (HPI), all we can do is seek to avoid or diversify risk and essentially, through this strategy you get maximum diversification.
How will rising interest rates affect gradual home ownership?
In the short-term, this is providing a huge boost for us on the asset supply side. People prefer to lock into something with us when their rents are going up with inflation albeit currently at around 10% whereas mortgage rates have more than doubled.
It’s that risk of interest rate volatility that is a cause of the fundamental financing problem, the reason why banks couldn’t lend what people could arguably afford to service. Because this risk of a 300bsp rise has always been there, now we are seeing it. This time, the interest rate shock is concentrated on the people who have just gotten on the housing ladder and have the least capital to absorb it. With us, while nobody likes getting a 10% increase in rent, at least they can manage it and our investors will get that return over the longer-term.
The other thing to remember is that there is no debt in the structure. So whatever interest rate people might be thinking about, that is an externality to our investments. This means there is no refinancing risk or negative equity risk. You can always earn higher headline returns by shoving debt into a strategy but what we’re looking for here is long-term stability.
What about the risk of falling property prices?
You have to distinguish between short- and medium-term. We have always looked at investing through the cycle, the whole thesis is that people are going to buy the properties and sell them after 7-12 years. During that period, prices will go up and down, individual properties might be more volatile, but we are only looking at the average of the whole portfolio and so far it’s playing out largely as we expected. But because there is no debt, it is irrelevant what the property is worth next month, what matters is what it is worth in seven years. We have put in some protections, so that nobody can buy the property from us for less than what we paid for it. And we limit the amount of staircasing to 5%, so that investors don’t see volatility in realised as opposed to unrealised losses.
How do you pick the properties you invest in?
This is where the technology magic comes in: our joint venture partner Wayhome has entered commercial arrangements with internet real estate companies like Rightmove and Zoopla. All of their data is grabbed by their computers and filtered to exclude things we would never invest in. What we are looking for here are middle market, middle England properties, be they terraced or semi-detached or low rise apartments, nothing complicated. Then we screen out properties where we think the yield isn’t sufficient, we are obviously targeting a certain return and a key driver of that is your day one yield. We can do that by benchmarking. There’s this massive screening exercise. And then comes the bit I like best; the customer takes over and decides which of the theoretically eligible properties they want to buy and live-in.
How does this affect the geographic distribution of your portfolio?
It’s all driven by customer demand. At the moment, Essex is our biggest sector, then several Southern counties, demand for houses in the Midlands e.g. Birmingham is also rising. In practice, customer demand comes from the areas where the wage and house price disconnect is the greatest.
Where does your strategy sit in terms of ESG compliance?
It is Article 6 because we don’t want to exclude anybody. If we wanted to make it Article 8, we would have to only invest in certain types of properties for environmental reasons or exclude people in certain income brackets. We have a very broad income distribution, we don’t just have the nurses, we also have the doctors. If we concentrate solely on low income or on new built properties, we concentrate risk.
Similarly, when it comes to energy efficiency, that would limit us to properties which are already A or B rated. Instead, we are dedicated to improving them via an improvement in EPC ratings. GHO provides a way to fund these improvements to occur. The decision to acquire a property takes account of the estimated costs of energy improvements both at the individual property level and across the entire portfolio.
That doesn’t quite correspond to the UK housing market does it?
Most houses were built in the 1930s to 1960’s and you don’t have to be a carbon scientist to figure out that knocking them all down and rebuilding them isn’t going to help.
Our strategy isn’t an impact strategy but speak to any of our customers and they’ll use words like impact, they feel like they are in control now and plan their lives. It isn’t big I impact but it has a massive effect on people.
Disclaimer
The Management Company may decide to terminate the arrangements made for the marketing of its collective investment undertakings in accordance with applicable de-notification regulation. This is a marketing communication issued by Allianz Global Investors UK Limited, 199 Bishopsgate, London, EC2M 3TY, www.allianzglobalinvestors.co.uk. Allianz Global Investors UK Limited company number 11516839 is authorised and regulated by the Financial Conduct Authority. Details about the extent of our regulation are available from us on request. The duplication, publication, or transmission of the contents, irrespective of the form, is not permitted; except for the case of explicit permission by Allianz Global Investors UK Limited. Contact details and information on the local regulation are available here (www.allianzgi.com/Info). This document is directed only at persons who are professional investors for the purposes of the Alternative Investment Fund Managers Regulations 2013, as amended, and is accordingly exempt from the financial promotion restriction in Section 21 of the Financial Services and Markets Act 2000 (“FSMA”) in accordance with article 29(3) of the FSMA (Financial Promotions) Order 2005. The opportunity to invest in the Fund is only available to such persons in the United Kingdom and this Document must not be relied or acted upon by any other persons in the United Kingdom. Investing involves risk. The value of an investment and the income from it may fall as well as rise and investors might not get back the full amount invested. Residential Property investments are highly illiquid and designed for long-term professional investors only. Performance of the strategy is not guaranteed and losses remain possible.
The Private Rental Sector (PRS) is undergoing transformation, and with that comes a significant investment opportunity. Ahead of the biggest UKREiiF event so far in May, G2M’s James Lancaster outlines why investing in existing PRS stock in particular delivers both greater financial returns than many might suspect, along with positive social and environmental impact.
