The last few years have seen build-to-rent move from theory and conference chatter to stabilised assets, generating income often in line with or exceeding expected yields. But the latest property trend still needs proper insurance policies, writes Michael Hobson, PRS consultant at Premier Guarantee.
Savills predicts the value of the BTR sector in the UK could reach £500bn at full maturity from today’s £10bn. This value has come across all major cities in the UK and latterly from smaller towns and cities where the numbers and demand stack up.
The events of the last 18 months have resulted in residential looking like an increasingly favourable bet for long-term institutional investors in comparison to other sectors in real estate which have looked uncertain by comparison.
Despite an estimated 90% of BTR units built to date having some kind of latent defect cover, as the sector matures and uncertainty over the model diminishes some may well be asking themselves if they need a structural warranty in place.
This is especially true if the likelihood of having to dispose of the units, either to another investor or the open market is deemed a lot less likely. It’s a fair question to ask for an up-front cost that can be considerable and may never be called upon.
Whether you refer to it as Latent Defects Insurance or structural warranty – it’s essentially the same thing but often misunderstood – forward funders and their advisors want it for some very solid reasons:
First Party policy
Firstly, it’s a ‘First Party’ policy not dissimilar to your fully comprehensive car insurance, which means the insurer protects interested parties against damage to the building resulting from defects in design, workmanship and materials.
Unlike collateral warranties and the professional indemnity insurance that underpins them, Latent Defect Insurance only requires evidence of ‘damage’ having occurred and not proof of negligence amongst consultants or contractor.
It’s also not reliant on those parties still trading and, as we know, even Tier 1 contractors are not immune to the risk of insolvency. Essentially the cover sits outside of the build contract and is fully assignable for the length of the policy, i.e. it does not limit how many times the asset can be sold.
Another notable discussion point is the hot topic of compliance and quality assurance. Well-established warranty providers will have their own in-house project managers and inspectors solely focused on managing risk in projects over six storeys. They have years of claims data which gives a unique understanding of when and how defects occur.
Unlike many areas of insurance there’s an opportunity to directly affect the risk and to provide advice on long-term durability and the lifespan of key structural and water-proofing elements.
Maybe this isn’t a high priority for developers exiting at completion, but for investors with assets held for 20-40 years it should be and often is a clear focus.
As the Building Safety Bill moves through Parliament, the expertise of those involved in the construction and inspection of ‘higher risk’ buildings will come under increasing scrutiny. When selecting the relevant compliance and consultant those responsible will need to be certain that the organisations in question have the suitable resources and processes in place to properly construct the required ‘golden thread’ information.
Despite the resilience BTR has shown throughout the last 18 months, we are still awaiting landing into a post-lockdown and post-furlough economy. However unlikely some commentators deem the likelihood of needing to dispose of BTR units into the open market, if there isn’t a structural warranty/latent defects policy to cover the first 10 years from completion, then a mortgage provider won’t be making offers to individual purchasers.
Passing the parcel
Risk transfer and mitigation both for contractor, developer and investor is a constant pass the parcel – especially where innovative methods of construction are involved. We find main contractors don’t want to take on the risk of such specialised elements for a defects period – here is where a latent defects policy works well, wrapping this all under one risk transfer. This is also possible for contractors (typically Tier 1) who baulk at a separate indemnity to a warranty provider.
Despite some insurers and providers pulling out of the latent defects market, there are new products in the market which means the upfront cost can be mitigated dependant on the risk appetite of the investor. Where an investor is comfortable with the covenant of the contractor and recourse through the build contract and collateral warranties, a large excess can be applied – sometimes up to 10% of the reinstatement value – to reduce the initial premium. Some even provide the option to port into an open market product or lower excess for a new purchaser at some point in the 10-year cover. This is a useful tool in large BTR schemes, especially those that involve multiple stakeholders where each respective party wants their own full reinstatement sum insured but there’s a necessity to keep the overall premium down.
As we await the new normal, it’s a brave soul who predicts with certainty what’s the right level of risk to set and which options will be needed. As Warren Buffet said, “someone’s sitting in the shade today because someone planted a tree a long time ago”.
When choosing an LDI provider, it’s essential to look out for one that’s able to undertake risk assessments, manage claims, cater for BTR projects built with traditional or modern methods and be backed by A-rated insurers.
Premier Guarantee’s BTR cover offers all of this as well as the flexibility you need for your next BTR project. Find out more about PRS Select.
- Michael Hobson is PRS consultant at Premier Guarantee