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Lloyds' landlord ambition offers test case for income-hungry European peers

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Quintain's massive build-to-rent development beside Wembley Stadium in north London is part of the rush to meet surging demand for high-quality, professionalized residential rental product in the U.K.
Source: Quintain

While banks owning income-generating real estate portfolios is nothing new, the recent revelation that Lloyds Banking Group PLC is planning to become a large private, residential landlord may have raised eyebrows in the industry.

Lloyds, which is the U.K.'s largest mortgage provider, is more used to financing home purchases than being the purchaser. It will be entering a highly fragmented sector dominated by retail investors, known as "buy-to-let" landlords, many of whom it will have financed.

The lender's plan, "Project Generation," aims to create a new income stream to offset the squeeze on its margins caused by historically low interest rates. With banks across Europe experiencing the same problem, the outcome of Lloyds' move will be closely watched.

"I can see other banks looking very intently at how Lloyds get on and how they're going to do this," Paddy Allen, head of operational capital markets at real estate services firm Colliers International, said in an interview. "When one bank beats a successful path, others tend to follow."

Safe as houses

Lloyds' attraction to the U.K. residential rental sector is understandable. A chronic national housing shortage has fueled a sustained rise in home prices in recent decades, increasing demand for high-quality, professionally managed rental properties as the prospect of buying becomes increasingly remote for many. The lender can also call on its vast knowledge of the sector through its mortgage and commercial lending divisions.

The bank has been forced to look beyond its core lending business by the low interest rate environment that has prevailed since the global financial crisis. Lloyds' net interest margin has remained stubbornly low in recent years, failing to exceed 1.74% since 2016, according to S&P Global Market Intelligence data.

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Prior to the COVID-19 pandemic's disruption of the property investment market, U.K. residential rental yields ranged from 3.00% to 3.25% for prime central London homes to 4.75% to 5.00% for secondary regional cities such as Liverpool, Sheffield and Newcastle, according to January 2020 data from real estate services firm Knight Frank.

"The U.K. private rented sector and senior living markets are likely to be pretty stable moving forward over the long term," said Mark Clegg, head of residential capital markets at multinational real estate services company Cushman & Wakefield. "We are seeing a huge amount of new capital looking at the sector."

Other European countries are experiencing similar market dynamics to those in the U.K. Home ownership in Europe's six largest economies, excluding Russia, ranges from 51.1% in Germany to 76.2% in Spain, offering substantial residential rental markets in each. A shortage of supply and increasing demand across each of these six markets has pushed up prices in recent years, making home ownership increasingly unaffordable for many renters.

Average residential rental yields in these markets range from lows of 2.40% in Berlin to 4.70% in Rotterdam, Netherlands, according to a 2020 report by European property and finance specialist Catella Group. Meanwhile, the average return on equity among EU banks was 2.19% in September 2020, ECB data shows.

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The right move

Some European housing markets are more suited than others for banks that would consider a move similar to Lloyds', said Allen. Germany, the Netherlands and the Nordic countries have highly regulated residential rental sectors and mortgage markets that make homeownership "fairly accessible" by offering long-term, fixed-rate loans, he said. "These markets aren't massively disruptable because they work," Allen added.

A major draw for European banks to the residential rental sector could be the chance to gain greater access to the huge market for household expenditure, said Allen. In the U.K. alone, household expenditure related to rent and mortgage payments, insurance, utilities and other outgoings is about £40 billion per year, based on the number of rental homes in the country and the average annual household spend, Allen estimated.

"It would make a lot of sense for banks to try and tap into that, and try to build an ecosystem and one-stop solution around that," said Allen. "There's a huge cross-selling opportunity given the level of household spend." The data generated from such customers would offer further value, Allen added.

Some analysts struggle to see property ownership becoming a significant source of income for European lenders. "Banks are looking for ways to diversify their revenues, which are likely to remain squeezed for some time," said Sam Theodore, an independent European banking analyst and consultant. "On balance, their capital levels are high and there is the obvious need to make capital more productive. Owning and managing properties is one way, but I do not really expect this to become a mainstream revenue producer."

Still, if Lloyds' move proves profitable, it is unlikely to be the last of Europe's lenders to consider becoming a landlord, said Allen. "If this is directly linked to creating more value from customers and creating stickier customers, some of the banks will potentially look at that and think it's something they've missed, and they need to do."