Rapid demographic change, the desire to live in city centres, the rising cost of housing together with an inexorably changing urban environment have raised the profile of apartment dwelling since the near-collapse of the global financial system in 2008. A new generation of renters, led by millennials, have swapped mortgages, commuting and the suburbs for the 21st century urban lifestyle. The attraction of a walk-to-work way of life jostling with shiny new light-rail systems amid gleaming new condos has been undeniable.
Hidden among all the excitement and the surging interest in urban investment opportunities, a growing crisis in access to affordable housing has been developing. Housing shortages have become a significant problem for major metropolitan authorities in Europe and across the world as they strive to meet the needs of growing city populaces.
Clearly, the urban trek has not gone unnoticed among investors who have flocked to investments in multi-family housing in gateway cities from Sydney to Seattle, attracted by the combination of housing shortage and depressed yields. Investors have realised that the low yet stable cash flow yield on offer from residential property is attractive. Moreover, trends in investing such as a greater emphasis on environmental, social and governance (ESG) criteria could spark further attention to social and affordable housing.
The market opportunity in affordable housing
One of the principal attractions of residential investment is the long-term supply-demand dynamic in Europe’s major cities. Demographics and geographical trends, such as the tendency for households to shrink, are contributing to housing shortages in sought-after, high-barrier-to-entry markets such as London, Berlin, Stockholm and Paris. The decline in home ownership rates in markets such as the US and the UK is indicative of broader trends. European markets have seen owner occupation fall from 73.2% in 2009 to 69.5% in 2016.[i]
At the same time, the rented housing sector in Europe is substantial and growing, with renters constituting more than 25% of households in the EU-28 and up to 50% in countries such as Germany (see Exhibit 1). Given social landlords’ ability to tap the bond markets – a facility they have had access to for more than 25 years – the growing investor interest in the potential of social and affordable housing is not surprising.
Exhibit 1: Proportion of people renting - national average & highest percentage in a city
The draw of cities appears unabated: urbanisation is forecast to rise over the next 10 years across Europe, with markets such as Germany and the UK expected to see a 2.5% increase in urbanisation by 2025, according to UN data. This should provide a significant impulse for demand for residential property, but also has implications for affordability. An EU Urban Agenda report from 2016 highlighted that 11.4% of EU-28 households spent 40% or more of on housing (see Exhibit 2) (Eurostat November 2015). The drop in investment in social housing between 2008 and 2012 has contributed to the affordability problems.[iii]
Exhibit 2: Proportion of households in the private rented sector spending 40% or more of their disposable income on housing
As mentioned, another factor behind investor demand for social and affordable housing could be the growing demand for investments that satisfy strict ESG criteria. Such requirements are beginning to guide investment strategies in both the listed and non-listed real estate sectors. A global study has found that the percentage of institutions that said their investment processes were influenced by ESG considerations rose to 29% in 2016 from 16% in 2015.
ESG has typically been associated with ‘green’ buildings. However, with affordability in urban areas a growing consideration for institutions, as well as the long-term sustainability of cities, affordable housing should be a core aspect of ESG investing, according to the 2016 Institutional Real Estate Allocations Monitor from Cornell University.[iv]
Affordable residential real estate options for institutional investors
As institutional equity investors have become increasingly interested in investing in residential property in general and more recently in affordable housing, the listed real estate securities sector has been investing more actively in residential. This looks set to continue as the prospects for returns look attractive against the backdrop of low interest rates.
Institutions have traditionally accessed affordable and social housing via the debt markets in the UK. There is now growing involvement by and increasing interest from equity market participants, particularly from private or non-listed equity markets and more recently from the public equity markets. Given the scale of the stock in the non-profit sector and events in markets such as Germany over the last 10 years, interest is developing.
The UK saw initial public offerings (IPOs) of social housing sector investment vehicles in 2016 and 2017 to raise funds to buy social housing assets from associations and local authorities.[v] Germany has been the catalyst in Europe for the growing interest in residential rented portfolios among investors. The expansion of the listed residential sector in Germany has been one factor. Demand for lower-risk, bond-like returns and the privatisation of large portfolios of social and affordable housing followed by IPOs have been other drivers.
The German sector expanded significantly with the privatisation of Deutsche Annington and its subsequent listing in 2013. After a number of mergers and acquisitions, the German residential sector is now an industry with a EUR 50 billion market capitalisation, making it an important sector for European real estate securities investors.
Will new capital flow into affordable residential real estate?
Demand for rental housing, shortages of affordable housing and a growing base of investors looking for stable, long-term returns could set a wave of new capital flowing into affordable residential property in a number of European markets.
Among institutional investors, there is greater appetite to buy into the sector. Many fund managers believe there are now more opportunities to build pan-European residential portfolios. An ‘emerging trends’ survey [vi] has highlighted the growing awareness of real estate and residential among equity investors. They have increased their allocations to real estate in public markets and in unlisted funds or by buying real assets directly.
With inflation and therefore interest rates expected to remain lower for longer in North America and Europe, the tailwind for residential investment should persist.
The biggest challenge has typically been how and where to invest. UK equity markets have begun to work with social housing landlords as the opportunity becomes clearer. In Germany, the focus has been on the more market-oriented segment of affordable housing.
It is likely that more structures will come to market, but the extent will depend on the scale of social and affordable housing moving into investible vehicles, the regulatory frameworks and the degree to which alternatives in the commercial property markets in Europe begin to lose some of their appeal.
The German model might well show the way, with companies first building portfolios from existing stocks of property, using dedicated investors with longer-term investment horizons as a source of capital, before looking to the public markets for equity.
Written on 06/10/2017
[i] Eurostat, Trading Economics, 2017 & The English Housing Survey, produced by the Department for Communities and Local Government, 2017
[ii] Eurostat, Trading Economics, 2017 & The English Housing Survey, produced by the Department for Communities and Local Government, 2017
[iii] European Union Urban Agenda report 2016: The challenge of “affordable housing” in Europe, by Laura Colini (URBACT expert)
[iv] Cornell University and Hodes, Weill & Associates’ October 2016
[v] Source: Bloomberg, as of 01/08/2017
[vi] Emerging trends in real estate Europe 2017