Jonathan Bayfield examines the fundamentals of this asset class, as well as the opportunities and risks for real-estate investors.
Read this article to understand:
- The fundamentals of institutional rental housing
- How to find opportunities and mitigate risks
- How challenges in the ‘for-sale’ residential market are supporting the relative appeal of English suburban single-family and Spanish urban multi-family sectors
Renowned Swiss-French architect Le Corbusier described a house as a “machine for living in”. If the same can be said of the housing market, it is a machine in need of repair.
In many countries, housebuilding has failed to keep pace with population growth, leaving many people without access to affordable housing. In addition, too much of the housing stock is energy inefficient, making it costly to run and a major contributor to carbon emissions.
But these structural dynamics are also leading to opportunities for real-estate investors, who can potentially access attractive returns while creating solutions to pressing social and environmental issues.
Traditionally, commercial assets such as shopping centres, office buildings and industrial warehouses have dominated the attention of institutional investors. But the rental housing asset class is becoming increasingly important. This shift is evident in the way the MSCI/IPD UK real estate index has evolved over the past few decades (Figure 1). At the end of last year, the rental housing sector (which is represented in the chart in the “residential” and “hotel” categories, and parts of the “other” category) constituted over six per cent of the index.
According to a forthcoming report from real estate services company JLL, the European rented residential real estate market is projected to surpass US$15 trillion in 2030. This would mark substantial growth from the US$10.7 trillion in assets currently identified across Europe. A market segment of this size clear warrants a significant opportunity.
Figure 1: MSCI UK Property Index (per cent)
Source: MSCI UK Monthly Index. Data as of December 2023.
The rental housing category includes any form of property specifically designed to be lived in, from student accommodation to retirement villages, from single- or multi-family housing to co-living complexes. In this vein, many prefer the “living sector” as a more apt label for this wider category. Due to the nascency of some of these sub-sectors, the majority of our analysis refers to the residential sector.
The largest factor influencing rental growth over the long term is employment growth
Our research shows rental housing (or “living” real estate) in the UK and continental Europe boasts robust fundamentals, explaining the strong growth in investment in recent years. Potential for income growth is being driven by long-term structural factors such as positive demographic trends. Our analysis has found the largest factor influencing rental growth over the long term is employment growth.
Residential property has demonstrated lower cyclicality compared to traditional real estate: while businesses may fold and shops may shut, people always need somewhere to live. This makes it a valuable defensive asset during periods of market uncertainty. Supporting this point, our analysis shows residential real estate has different risk drivers to commercial real estate, offering diversification benefits to investors. It has also showed greater resilience in past downturns.
According to Savills, over the last 25 years, residential rents have been more stable than house prices, particularly during the Global Financial Crisis.1 Compared to other property sectors, residential rents showed the greatest resilience during the crisis, experiencing the smallest decline (-2.2 per cent at its lowest point in late 2009). This compared favourably to offices, which saw a 13.5 per cent fall, and retail, which fell 5.4 per cent.
The residential sector exhibits a lower standard deviation of returns when compared to commercial sectors in various global markets
Additionally, according to MSCI data, the residential sector exhibits a lower standard deviation of returns when compared to commercial sectors in various global markets.2 This track record of lower volatility is appealing to many investors.
Entering a real estate market can sometimes pose liquidity challenges for investors. Nevertheless, unlike other sectors, some residential investments could be subdivided for the “for-sale” market, negating some of those concerns. Whilst Northern European markets, like Germany, the Netherlands and Scandinavia, are some of the most established markets globally, other locations are now maturing. This has led to greater investor interest, which has also improved liquidity generally. This is particularly pertinent as commercial investment volumes have been significantly down of late, whilst investment in the living sector has held firm.
Markets and geographies
While these asset-class characteristics tend to hold true across locations, venturing across borders into new markets can be complex and investors must consider geographical nuances. Each city has its own distinct residential market, thanks to unique macroeconomic, region-specific and legislative factors.
To navigate this complexity, we have chosen four related parameters to identify markets we believe offer the most compelling opportunities (Figure 2).
First, markets that exhibit affordability issues, indicative of a supply/demand imbalance, tend to have the greatest need for investment.
Take the UK. Our screening analysis focuses on key metrics like the house price-to-earnings ratio and amount of time required for individuals to raise money for a deposit. For instance, the average UK house price-to-earnings ratio has approximatively doubled over the past two decades (Figure 3). Notably, peaks are observed in London and Southeast England, where housing construction has lagged population growth. This has made it more difficult to buy a house and increased the time needed to save for a deposit (Figure 3).
Figure 3: Affordability constraints in the UK (for those aged 30-40)
Source: Aviva Investors, UK ONS, HM Treasury, Oxford Economics, Bloomberg, December 2023.
Population growth is key to driving housing demand across Europe. Figure 4 examines population forecasts across the continent; the darker colours signify the potential for higher population growth. This often translates into long-term prospects for employment and rental growth, and is therefore a potential tailwind for rental housing. We are more cautious on the areas in white, which show a more muted outlook.
Figure 4: Population growth forecasts 2023-2027 (per cent)
Source: Oxford Economics, Eurostat, Swiss FSO, UK ONS, Aviva Investors. Data as of Q4 2023.
Supply constraints are another important consideration. As long-term investors, we are wary of rental housing assets in markets globally where land tends to be more abundant and therefore cheaper. But in Western Europe and the UK, supply constraints are often evident, manifesting at both a city and national level.
According to The Housebuilding Crisis report by Centre for Cities, the UK is grappling with a severe housing deficit, with 4.3 million homes missing from the market. Unsurprisingly, the situation has set in motion a domino effect, with these pressures fuelling strong demand for rental accommodation.
In continental Europe, Barcelona is an example of a city with supply constraints, as it is geographically limited by the sea and nearby mountains. In the UK, constraints have more to do with the country’s localised planning system. Figure 5 shows the number of planning applications granted is more than double the number of housing starts. The number of homes available to rent in Q3 2023 on Rightmove, an online rental site, was a fifth lower than the average number of quarterly listings over the 2017-2019 period.3
Figure 5: The UK’s planning system by dwelling type
Source: Aviva Investors, UK ONS, Savills. Data as of 2022.
Lastly, it is important to look at the investor base. Not all European markets are alike; some have less institutional activity than others. The UK and Spain are good examples, with institutional ownership representing just two and five per cent of the total in each country, respectively (Figure 6). This indicates substantial growth potential for investors that participate early and help create new markets.
Figure 6: Institutional ownership of private rental market (per cent)
Source: Aviva Investors, Green Street, CBRE; January 2024.
UK single-family housing
Based on our analysis, two sub-sectors stand out as representing particularly attractive opportunities: UK single-family rental (SFR) and Spanish build-to-rent (BtR). We’ve been able to make substantial investment in these areas thanks to headwinds to the for-sale market, creating challenges for many developers and housebuilders and putting downward pressure on land prices.
Despite being a relatively new sub-sector, SFR investment saw a big surge in 2023
The UK SFR segment offers opportunities because of the unaffordability of the for-sale and rental market, partly driven by the supply conditions and partly driven by historic loose lending to home-owners. SFR is also relatively immature compared to other sectors, has lower gross-to-net leakage (the difference between gross rental income and the same figure after costs have been deducted) and lower obsolescence risk. Therefore, in our view it offers superior risk-adjusted returns at present.
Despite being a relatively new sub-sector, SFR investment saw a big surge in 2023. According to JJL, the UK SFR market attracted £2.8 billion in investment in the first half, with 9,400 institutional SFR homes built and an additional 11,900 in the pipeline.4 This is in part driven by many housebuilders looking for capital to de-risk their developments. Since the final quarter of 2022, Aviva Investors has committed to over £500 million of capital in SFR deals.
Figure 7 shows institutional ownership of the UK SFR market is expected to grow to five times its current size, reaching 50,000 homes by 2025.
Figure 7: Institutional ownership of UK-single family housing by sub-sector (number of homes)
Source: JLL, June. Data as of 2023.5
To select potential locations for investment, we use a bespoke proprietary toolkit using 22 key metrics. Among these, we assess macro fundamentals at a local-authority level, including disposable income, GDP and unemployment rates. We also analyse demographics, with a particular focus on historic and forecasted growth of populations aged 25-45. The most important category is the residential market, which includes various affordability metrics, as well as the number of dwellings in a location and rental growth statistics.
Figure 8: Our pipeline versus ownership
Source: Aviva Investors, Packaged Living. Data as of January 2024.
Following this location analysis, two of our most notable SFR developments include one in Milton Keynes in Buckinghamshire, which comprises 117 homes within walking distance of a train station that provides a regular service to London; and a second in Bordon in Hampshire, comprising 174 homes.6
On both projects, we are working with Packaged Living, a specialist UK BtR platform which focuses on both multi-family and SFR. It will oversee the development and ongoing management of these rental housing assets.
In line with our commitment to achieving net zero across our real assets platform by 2040, we put strong emphasis on sustainability.7 Our SFR property designs include features such as electric-vehicle charging stations, air-source heat pumps and electric solutions for energy. We are targeting an EPC-A rating to minimise ongoing energy requirements and costs for occupiers.
New geographies in continental Europe are also seeing increasing interest from institutional investors for residential real estate, with Spain a key target. According to Iberian Property, nearly €1.5 billion was invested in BtR properties in Spain in 2022, with transactions including almost 6,000 units.8
Figure 9: Investment in BTR in Spain
Source: Aviva Investors, Iberian Property. Data as of March 2023.9
This reflects strong fundamentals in Spanish residential real estate, where rental demand is being driven by supply constraints and unaffordable property prices that make home ownership difficult for many.
The long period of low mortgage rates has created an unaffordable for-sale market
The long period of low mortgage rates has created an unaffordable for-sale market. Caixa Bank’s analysis of the ten most populated cities in Spain found high rents make it difficult for many to save enough to purchase their own homes.10 Less than ten per cent of renters could buy a home given their income and savings in cities such as Barcelona, Bilbao, Zaragoza and Palma de Mallorca.
From a demand point of view, we like major cities such as Barcelona and Madrid, which have positive socio-demographic trends, strong inward migration and well-established workforces. Selectively, we also see opportunities in regional centres like Palma da Mallorca, Malaga and Valencia.
On the supply side, Barcelona’s geography is restrictive and recent policy has also impacted development. In Madrid, there is a strong municipal land use zoning policy, which is slowly controlling development, whilst Palma da Mallorca’s residential market is limited thanks to tourist uses and the fact it is located on an island.
Location is critical, however, which has led us to focus on areas with service infrastructure and good public-transport links.
Figure 10: Investment in BtR by city, 2022 (per cent)
Source: Aviva Investors, Iberian Property. Data as of March 2023.11
We have a strategic partnership with a leading Spanish developer, Layetana Living, to embark on the creation of a sustainable urban multi-family portfolio in Spain exceeding €500 million GDV, based primarily on ground-up development.
Figure 11: Housing affordability index for renters versus savers (per cent)
Source: Aviva Investors, CaixaBank Research. Data as of Q4 2019.
Our target is the mid-market – the main source of demand due to the lack of quality affordable housing in Spain. Before investing, we carefully assess how rental rates sit in relation to household incomes, ensuring their long-term affordability. We have also created a sustainability framework to guide development and ensure the resulting assets are environmentally friendly (as detailed below), safe and comfortable to live in.
We carefully assess how rental rates sit in relation to household incomes, ensuring their long-term affordability
As an example, we have an 85-unit scheme situated in Terrassa, Barcelona, which is due to complete in Q1 2025. The development provides dedicated amenity facilities including a swimming pool, a BBQ area, a resident lounge and co-working facilities. It has also been designed sustainably; all power is electric, there is an on-site solar photovoltaic (PV) system, and there is only 406 kilogrammes CO2/sqm of embodied carbon and 59.7 kilowatt hours/sqm/year of energy use intensity. In addition, residents will benefit from smart home technology, EV-charging facilities and a dedicated CRM app to enhance the living experience. It has been awarded an EPC AA and BREEAM Excellent rating.
Implications for investors
As with all real-estate projects, the specific nuances of each location are crucially important in future-proofing assets: proximity to amenity rich locations, train stations and good schools are all crucial in fostering long-term demand.
While we see lots of opportunities emerging across the continent in the wider living sector over the coming years, investors must also consider risks that are particularly pertinent to the rental housing sector.
Rental housing investments are especially sensitive to changes in interest rates
First, rental housing investments are especially sensitive to changes in interest rates. For example, an increase in base rates can impact low-yielding assets and decrease activity in the for-sale market.
The rental housing market can also be strongly influenced by regulation, so housing policies need to be closely monitored in each country. These policies can be tweaked relatively easily, causing uncertainty.
Take measures like rent control. Such policies can limit the potential cashflow upside for investors during good times while providing stability for renters and markets in volatile times. In Portugal, for example, the relaxation of restrictive rent-control regulations led to significant upheaval in the rental market, which had knock-on effects for lower-income earners.
Nevertheless, rent-control measures can sometimes have unintended consequences. In Scotland, developers have been discouraged from starting new schemes due to uncertainty and reduced viability of schemes.12
The ability to build at scale and tap into local expertise is crucial
Given the rental housing market is still relatively immature in some European locations, despite recent growth, the ability to build at scale and tap into local expertise is crucial. Choosing the right partners is paramount, since they can offer operational expertise, origination expertise and help mitigate reputational risk. Conducting thorough due diligence and gathering comprehensive information during the lease-signing process is also vital.
But for investors who can undertake the necessary analysis and forge the right partnerships, investing in rental housing could offer opportunities to diversify portfolios and achieve attractive risk-adjusted returns. And by creating efficient living space for local communities that helps to limit their fossil-fuel usage, investors can also play a part in improving the housing market machine.