Nest’s new flats: a good bet for savers, but not for ministers

An unusual new player entered the residential property market this week. The National Employment Savings Trust, the state-backed default pension fund used by 13 million low and moderate earners, set out plans to build, own, let and maintain thousands of inner-city flats.
At a stroke, a third of the nation’s workforce are to become landlords (albeit indirectly and in a very, very modest way, of course). For the first time, their pension pots will be augmented by rents collected from future tenants.
Nest, which in recent years has mushroomed into a big investment institution managing £44 billion of the nation’s long-term savings, will add apartment blocks to the assets in which it already invests. These include shares, bonds, infrastructure, private equity and forests.
It is chipping in an initial £150 million, with PGGM, a Dutch pension fund, investing a similar amount and Legal & General, which will manage the overall operation, putting in £50 million of its own capital. The three partners expect the bet to expand to £1 billion within a few years. Loaded with debt, which is normal for such deals, residential property could soon be a significant part of Nest’s investment mix.
It is not alone. This week The People’s Pension, a workplace pension provider that manages the pension pots of six million workers, said it was pushing into private assets including real estate, with residential property a clear possibility.
So-called build-to-rent should be a natural asset class for these defined-contribution pension funds, which have mostly younger members. They have huge net inflows. Nest has to identify new investment opportunities to absorb £18 million of employee and employer contributions that come in every day. So they are strongly placed to stump up the heavy up-front costs of new blocks of flats. A reliable income stream from rents decades into the future should produce strong returns. And the inflation-proofing is attractive, too: rents tend to rise in line with wages, which tend to rise faster than prices.
Yet this is a relatively recent asset class for institutional investors and progress has been slow. In the past eight years, 106,000 build-to-rent homes have been built, according to research by Savills. Not a huge amount in the context of the 1.5 million new homes that the government wants to see built in the next five years. Build-to-rent accounts for only about 2.5 per cent of the 4.6 million homes in the private rented sector.
Planning paralysis and skill shortages can make for slow progress. The John Lewis Partnership, for one, recently ditched its ambitious targets for non-retail projects, including building and letting flats on top of its stores and warehouses.
The costs of build-to-rent are much higher than passively tracking shares in an index. That means higher fees. The illiquid nature of property also makes valuation more difficult. This is a particular headache for defined-contribution schemes, which need to offer daily pricing as their members transfer in and out.
So the returns are not assured. In the inter-war years, Prudential was a significant domestic landlord, but it pulled out after tighter tenant protection rules hit the business model. In modern times, tougher standards and less favourable tax treatment have dented returns again, especially for smaller “amateur” landlords.
The pledge this week by Ed Miliband, the energy secretary, to force landlords to retrofit homes to meet minimum energy efficiency levels is good for the planet, but it’s another headache for the landlords of draughty Victorian properties. Incidentally, that measure won’t bother Nest, which says all its new flats will be net zero by 2030.
If moves by Nest and others get more homes built, that has to be good news for renters and for would-be homebuyers, helping to increase supply and putting downward pressure on prices. One reservation, though, is the role of the government. The only job of Nest is to act in the best financial interests of its savers. That’s a fiduciary imperative. It must not allow itself to become an instrument of wider government policy, however commendable ministerial aims such as building more homes or promoting economic growth might be.
To that end, it was unedifying to see Emma Reynolds, the new pensions minister, piggy-backing on the Nest announcement. It contained a quote from her applauding Nest for “harnessing the financial power of pensions to deliver more of the homes this government has pledged to build”.
Nest is very far from being independent of the Department for Work and Pensions. Its directors are appointed by the department and it has taken £1.13 billion of loans from the government to get itself off the ground, loans that still have to be paid back. Therefore, it potentially is vulnerable to the risk of political pressure.
It must not be seen to be influenced by ministers one jot in how it invests its members’ money. It was perhaps a little hasty last year in signing up to the Treasury-choreographed Mansion House compact, a pledge to put at least 5 per cent of members’ contributions into private equity by 2030.
Mass-market master trusts like Nest have done comparatively well in their first 15 years, partly because they have invested largely in cheap equity tracker funds and have resisted the urge to diversify into more expensive asset classes, as the Association of Consulting Actuaries has now pointed out in a report.
The push into residential property looks a reasonable bet and Nest insiders insist that the decision was entirely independent. But it would be a disaster for the credibility of this powerhouse of the auto-enrolment project if it were seen to be allocating customers’ money to please ministers. Simply maximising retirement incomes for low earners will be quite enough of a challenge.
Patrick Hosking is Financial Editor of The Times