Scotland's bid to attract investors to its barely established build-to-rent sector is being hampered by the prospect of rental controls as the country's government wrestles with a housing shortage and demands to protect tenants from runaway rents, senior market figures have told S&P Global Market Intelligence.

The Scottish Parliament — a devolved U.K. authority with legislative powers similar to those of a U.S. federal state — passed a bill in March 2016 that enabled the creation of rental pressure zones aimed at limiting rent increases in areas that had seen excessive rises. The act allowed the city council of Edinburgh, Scotland's capital and second-largest city, to pass a motion in July 2017 that could see rent controls introduced as early as December when the legislation comes into effect.

The move by Edinburgh Council, which The (U.K.) Sunday Times reports could be echoed in Glasgow and Aberdeen, comes as the Scottish government is trying to attract investment to the country's nascent build-to-rent sector. The government published a market engagement paper in February 2016 setting out proposals for a rental guarantee scheme for build-to-rent developers, whom it sees as playing a key role in addressing the country's part in a massive housing shortage affecting the whole of the U.K. The national government and Edinburgh City Council are controlled by the Scottish National Party.

Moda Living, one of the few build-to-rent developers that has committed to investing in schemes in Scotland, with one in Edinburgh and another in Glasgow, said the introduction of rental controls could "spook" investors. "Growing demand and the severe lack of quality accommodation are the real reasons for cost rises, which rental controls will unfortunately not address," Managing Director Johnny Caddick said in an emailed statement. "Discouraging investment into building new quality rented homes or upgrading existing stock at a time when momentum within the build-to-rent sector is beginning to gather pace should be avoided at all costs, and the introduction of rent controls could easily apply a brake to this growth."

Landlords in rental pressure zones, which must be approved by ministers in the Scottish government before they are established by local councils, would be limited to raising rents by the rate of consumer price index inflation plus 1%. Meanwhile, under the government's proposed rental income guarantee scheme, it would cover 50% of any shortfall in a build-to-rent developer's projected income from a scheme, with the ceiling set at 95% and the floor at 75% of the projected revenue. An announcement on turning the proposals into law is expected in the coming weeks, according to two of the industry figures.

Dr. John Boyle, director of research and strategy at Scottish property specialist Rettie & Co., which worked on Moda Living's Scottish land acquisitions and is advising several other build-to-rent investors interested in the market, said the conflicting pieces of legislation were slowing progress in the sector. "It's a bit like using the accelerator and the brake on the car at the same time — you tend to stall the car if you do that. There is a slight incongruity about the whole thing."

Scotland's build-to-rent sector lags the rest of the U.K. by some distance. There is only one recognized build-to-rent scheme operating in Scotland — the 345-unit Forbes Place in Aberdeen owned by LaSalle Investment Management Inc. — and Scotland has nearly 3,000 build-to-rent units in its pipeline, according to Rettie & Co. Across the U.K., there are nearly 16,000 completed units and almost 70,000 homes in the construction and planning stages, according to Savills.

The introduction of rental control legislation caused investors to "be a little bit uncertain about the direction in Scotland," Scottish Property Federation Director David Melhuish said in an interview. However, he added that build-to-rent investors will see how the policies play out in practice and "get to grips" with the situation.

Scotland has experienced several years of uncertainty since a referendum on Scottish independence from the U.K. was announced in March 2013. The hotly contested vote in September 2014 resulted in a 55% to 45% win for those wishing to remain part of the U.K. However, the U.K.'s vote in 2016 to leave the European Union has raised the possibility of a second Scottish independence referendum as Scotland voted 62% to 38% to remain in the EU.

This "political noise" has caused build-to-rent investors to opt for the relative safety of other parts of the U.K., said Boyle. "UK funds in particular are worried about [a second independence referendum] and that's not because they are politically partisan," he said. "If they thought they could make a better return out of an independent Scotland they would support it. It's just because they don't like uncertainty."