The UK government published its Planning Practice Guidance (PPG) for ‘Build to Rent’ (BTR) in September of 2018. It was a landmark moment for the sector as it acknowledged the potential of BTR to make a positive contribution to the UK housing supply and to placemaking; as well as the need for a bespoke planning approach tailored to the sectors business model and distinct economics.
In the past 10 years, the BTR sector has experienced substantial growth in the U.K. both in London and increasingly in the UK regions. According to the British Property Federation, at the end of 2018, there were approximately 131,855 new apartments, an increase of 26% over the previous year (including 25,655 completed, 41,870 under construction; and 64,320 in planning). For the first time, the number of apartments outside of London (64,738 – 49%) was roughly equivalent to the number apartments in the capital (67,177 – 51%).
The new BTR projects are increasingly larger and delivered through new buildings purposely designed and built for BTR with unique layouts, features and specifications that set it apart from the rest of the residential sector. The number of units has increased considerably from an average of 125 for completed projects, to 248 for projects under construction and 332 for projects in planning. The number of projects under construction with more than 500 units has also increased from 24 in 2017 to 34 in 2018. In London, purposely built schemes compromise approximately 70% of the completed stock, overtaking the stock delivered through conversions and ‘permitted development rights’.
The rapid growth of the BTR sector has increasingly put pressure on the UK planning system to overcome barriers to institutional investment and the development of new projects. The PGG seeks to address the challenges of the existing regulatory framework with bespoke solutions that set out qualifying criteria and requirements specifically for BTR. It provides guidelines to both Local Planning Authorities (LPA’s) and the private sector aimed at readjusting the planning system which is seen as favouring the delivery of projects for open market sales and the short-term trading of land for planning gain.
Planning barriers to institutional investment and development of BTR
Several constraints within the planning system together with a lack of experience across local authorities act as deterrents to institutional investment and development of BTR projects. The barriers often cited include uncertainty and lack of flexibility in regulations, predictability and speed of decisions; and the negotiation of obligations relative to affordable housing and community contributions (e.g. ‘Section 106′ and ‘Community Infrastructure Levy’ (CIL)).
The acquisition of land for BTR development without planning entails an uncertain and unpredictable route through the planning system. The risk of prolonged planning negotiations with uncertain outcomes and significant associated costs often make institutional investors and lenders averse to planning risk and thus not willing to provide funding without a consent in place. Obtaining consents often requires extensive negotiations with local officials with discretion over policy determinations and has substantial upfront costs.
Building regulations and planning controls are tailored for open market sales and are often fragmented and inconsistent across cities and boroughs thus undermining the viability of BTR projects. For example, car parking provisions are inappropriate for BTR occupiers, particularly in urban locations near public transport. The need for units to have dual-aspect and not be North facing undermines the possibility to optimize floor plans and units per core (subject to satisfying fire regulations). Also, the unit mix and amenities of BTR projects are also different and the requirements for larger units, such as those with 3 and 4 bedrooms and private outdoor space, are often not justified in dense urban environments.
Planning obligations such as S106 and CIL are also tailored for the open market sales model and not suited for the BTR business model and its distinct economics. For example, the ‘clawback’ provisions typically implemented in open market sale projects do not apply to operating income from annual rents. Furthermore, the additional cost of consented land and obligations tend to be passed on to the developer thus inflating land costs rather than reducing vendor’s expectations. As a result, planning obligations are added to the gross development costs of BTR projects, reducing profit margins and further undermining their financial viability.
The obligation to provide the same levels of affordable housing (or a financial payment in lieu thereof) creates a viability issue for many BTR developments as margins tend to be tighter than projects with open market sales. When the same level of obligations is applied to both models, it often undermines the viability of BTR projects resulting in lower residual land values compared to for-sale projects. Furthermore, the division of management within projects can reduce operational efficiencies.
When BTR schemes are not deemed viable with the level of obligations required, developers can negotiate a reduction in the affordable housing requirements using a financial viability assessment (FVA). However, as it is up to each planning authority to set out its own policies in planning guidance, the FVA process requires extensive negotiations which add an additional element of uncertainty and discretion while, at the same time, allowing for potential abuses.
Given the challenges of obtaining planning, land with consent has a substantial cost premium, with the value uplift estimated to be c.£9 billion a year. Most of the planning gain benefits vendors as less than £2.8 billion is captured by the CIL and Section 106 contributions. As a result of the uncertain planning process and potential increment in land values, part of the developers, consultants and property finance firms are geared towards de-risking the early stages of the development process through the grant of planning consents. The investment strategy is based on short-term trading of land based on the acquisition of sites without planning, often with the use of ‘planning gain’ finance; looking for the uplift in value from the sale of land once a consent is granted.
The additional cost of the increased planning certainty is often not justified as consented projects are typically designed for sale and require an extensive redesign to fit the BTR model. There is often the need for additional amenities for residents, ‘back of the house’ areas for on-site staff, reduction of parking, redesign of lobbies and changes to the unit mix and layouts. There is also often a need to optimize design efficiencies (e.g. net to gross ratio; wall: floor ratio; window: wall ‘glazing’ ratio; units per floor per core; balconies) and standardize design elements (e.g. façade; fit-out) and specifications.
The planning system already provides mechanisms to improve certainty (e.g. outline planning permission, detailed planning briefs, pre-application consultation) as well as ‘fast-track’ procedures to deal with ‘non-material’ amendments (e.g. Section 73). However, these mechanisms often do not provide the certainty required by institutional investors as they are
unable to deal with the changes to the design and modification of obligations required to make BTR projects viable. As such, it is often necessary to submit a new planning application after purchasing sites which reintroduces the element of planning risk which the additional cost of the planning consent should have eliminated.
The uncertainty of the planning system and potential for planning gain distorts the development process and property finance industry as it separates the activity of obtaining planning from the actual development and management of BTR projects creating two separate sources of finance. Early stage land developers with access to ‘planning gain’ finance which has high interest rates, are incentivized to maximize densities in order to increase land values to the detriment of the financial viability and delivery of projects. BTR developers and operators with access to development finance, can only acquire land with planning at a premium, and are then left with the choice of either developing projects that already have consents or redesign them to fit their objectives by taking the additional planning risk, rather then developing projects to suit their requirements within the confines of pre-established building envelopes.
Figure 1. Manchester Piccadilly Strategic Regeneration Framework. Aerial View.
BTR Planning Policy Guidelines
The PPG seeks to support the growth of the BTR sector by addressing the barriers within the planning system to institutional investment and the development of new projects. For the first time, it provides a definition of BTR and how it differs from other residential developments. It provides guidelines on how local authorities should handle planning policy, viability, obligations and how they can retain control over the tenure once permission is granted. The key guidelines include:
A new BTR definition: a single building with 100% of the units privately rented, professionally managed in single ownership and offering tenancies of 3 years or more.
Flexibility in space standards: Local authorities do not need to require BTR developments located within local plans to follow the national space standards without having to remove optional standards for local plans as a whole.
A new threshold of affordable housing: benchmarked at 20% with some scope to be provided off-site. Developers can seek to meet affordable housing requirements by agreement via a commuted payment (in lieu of on-site provision) or can deviate from the 20% benchmark by making a case on the grounds of financial viability.
Affordable Private Rent (APR): APR can be set at up to 80% of market rent (inclusive of service charges) and is to be maintained in perpetuity. The set discount is calculated upon for each new tenancy or renewal by tracking market rental growth within the development. Both market and APR units should be managed by the BTR operator.
The proportion of APR: Beyond the grant of the planning permission, developers can also vary the proportion of APR units and discount offered across a development over its lifetime, if it is consistent with the overall affordable housing contributions secured within the S106 agreement.
Restrictive covenants and clawback provisions: Section 106 agreements should be structured to include a clawback mechanism in case private market units are disposed of prior to the expiration of an agreed covenant period or if APR units are converted. The clawback sum is calculated as the sale price multiplied by the percentage discount applied.
Criteria for APR occupancy and eligibility: Subject to final determination by the BTR operator, rather than the local authority in order to avoid lengthy negotiations and delay in the planning process.
Assessment of the BTR policy guidelines
The PPG was generally welcomed by the BTR industry and local councils. It introduced specific policy changes to improve the viability of BTR projects while strengthening the hand of developers and investors. However, it was also generally considered not to go far enough in providing further certainty on the planning process while creating further deterrents in the clawback mechanism and tenancy periods.
The policy changes introduced by the PPG can expedite the planning process as applications no longer have to repeatedly secure deviation from the affordable housing policies of existing local plans by exhaustively demonstrating that traditional forms of affordable housing provision are not viable. Furthermore, they increase flexibility by allowing schemes not to follow strict national space standards within certain parameters. Maintaining inherent flexibility at the application stage is vital to the LPA’s ability to improve the viability of BTR schemes through planning conditions in S106 agreements, space standards and tenancy periods.
The PPG also recognizes that too restrictive of a covenant policy may be a deterrent. Onerous covenants that restrict use may deter investment as they may hinder the ability of investors to exit should market conditions necessitate full or partial disposal (i.e. break up and sale). To that extent, the current ‘clawback’ mechanism protects the interests of the local authority whilst improving the flexibility and certainty for the developer.
However, most of the policy definitions are left to the Local Planning Authorities which have struggled to produce up-to-date local plans. As of December 2018, only 44% of local authorities had an up-to-date local plan. The guidelines for LPA’s are unclear and do not specify how the
need (and demand) is to be identified and differentiated from those open market sale projects, as well as what specific spatial policies can promote BTR developments.
The introduction of a specific BTR use class has been advocated within the industry to allocate specific sites or requiring an element of BTR on larger sites in order to accelerate delivery. Clearly that would have some positives and some negatives. Some within the industry are of the view that if BTR is positioning itself as a separate asset class, it should be defined as such planning wise. However, this is not popular with institutional investors and developers whose outlook and disposal strategies are fluid and look to take advantage of the residential market’s volatility by keeping their exit options open.
The introduction of DMR optimizes affordability as it delivers a tenure-blind product for occupiers while allowing it to be managed by a single investor. It enables tenants to ‘staircase’ between rents while allowing for alternative units to become DMR. This allows the whole scheme to stay at the 20% for the whole of the agreed covenant which improves viability as the blanket 20% APR approach proposed would render many sites unviable for BTR, or unable to compete for land with alternative uses. BTR developments can satisfy this obligation by ensuring that at least 20% of the units are always let on APR. Units can be tenure blind within schemes and be ‘pepper potted’ among open market rental units.
At the same time, the process of identifying and agreeing on APR occupancy and eligibility criteria may become increasingly complex as Local Authorities seek to exert greater pressure and influence on developers. Determining what constitutes a ‘reasonable’ position in negotiations will be important.
The possibility to have one single operator for both market and DMR units improves operational efficiency as it allows projects to be managed holistically. It also means that investors can value the investment over its lifetime, programme repair and maintenance of a building without having to negotiate with a third party.
However, it is unclear how the three-year tenancy requirement would be assessed or policed, and some developers may find this unduly restrictive. Although longer tenancies would provide stability for renters, the majority tend to favour flexibility and prefer to commit for periods of a year with open-ended tenancy.
Furthermore, there is a lack of coordination with the Greater London Authority (GLA) as the PPG requires local authorities that seek to deviate from APR proportions and discount levels to justify it through a Local Plan viability assessment (prior to inclusion with Local Plan policy). This creates a disjoint between the GLA’s ‘fast track’ route target of 35% and the national rate of 20%. The London plan recommends that BTR schemes would need to deliver at least 35% of affordable housing at least 30% being at London Living rent level and the remainder being set at a range of below-market discounts to be decided with the Mayor and/ or the borough. The GLA also suggests in the latest London Plan that it would have to be an RP to manage the social rented units.
Conclusions: A step in the right direction but more still required
The PPG deserves to be welcomed by the industry. It provides a clear statement of support to the sector with guidelines based on an understanding of the BTR business model. Its policy guidelines should expedite the planning process of BTR schemes by increasing flexibility and improving viability in order to facilitate the development of BTR schemes and attract additional institutional investment into the sector.
At the same time, more is still required to increase the certainty and cohesiveness of the planning system particularly in the earlier stages of the development process. Delays and the need to revisit planning permissions are extremely costly, especially on large sites. Small and medium-sized developers could benefit the most from increased certainty as lenders and funders would be more willing to provide finance and equity capital.
The tailoring of planning obligations and space standards to BTR is a positive given that these have been mostly structured for open market sales and are often not suitable to the BTR model. A further improvement could see the introduction of ‘neutral’ mechanisms that could be applied across all asset classes while allowing developers and investors to determine the highest and best use of sites without being affected by the specific obligations pertinent to a particular use.
Further planning and fiscal mechanisms are also required to reduce the uplift in land values resulting from the grant of planning consents and incentivize the development of projects once consents are granted rather than the sale of the land. While a higher portion of the planning gain should certainly be captured through ‘value-capture’ mechanism (e.g. land value tax), there is also a need to reduce the planning risk premium associated with land without consent (and hence the planning gain resulting from the consent). By improving the certainty of the planning process in timing, outcomes and obligations required, more institutional investors and lenders would be willing to provide funding prior to planning consent, thus combining the processes of obtaining planning and building the projects as part of the same development process.
The role of the LPAs is crucial to support the growth of BTR by increasing the certainty of planning process and actively facilitating the development of new projects through the inclusion of specific BTR policies in local plans as well as using public land through joint ventures based on deferred receipts with development partners. The industry must also play a role in fostering further dialogue between the public and private sectors and in actively monitoring LPA’s in order to further support the growth of BTR in the UK.