This article is sponsored by Pictet Alternative Advisors
Investors around the world are turning to multifamily residential as a resilient income-producing investment. However, gaining exposure to the sector is not easy.
It requires specialist management, which is often lacking, especially in those markets where it is a relatively new part of the property landscape, and pricing is keen.
Many of Europe’s major cities remain fundamentally undersupplied with residential real estate, particularly affordable rental properties. At the same time, regulatory pressure on landlords is growing and the coronavirus pandemic is set to accelerate changes in the way people wish to live in cities.
Pictet has recently raised €700 million for its first real estate fund, which is looking to invest up to 50 percent in the ‘beds’ sector, including multifamily. Zsolt Kohalmi, global head of real estate and co-chief executive of Pictet Alternative Advisors, a subsidiary of Swiss investment manager Pictet, shares where change is needed and how technology and specialist management will help the market evolve.
What are the challenges facing the multifamily residential business?
The fundamental macro point about multifamily is that there is a mismatch between supply and demand, and this is the case in many countries across Europe. We are seeing decreasing levels of home ownership and a generation which is looking for the flexibility that renting offers, yet the supply side is frequently not quite matching. Furthermore, much of the supply – particularly new supply – is not at a price point which matches where the rental demand really is. By way of example, in London a lot of the new developments were obviously bought at very high land prices, which resulted in buildings at high price points.
In some markets, such as the UK, only a tiny percentage of the residential market is accounted for by professionally managed multifamily. In those European markets along what I like to call the Swiss-Scandinavian axis – Switzerland, Germany, the Netherlands and Scandinavia – the sector is far more established. However, it is challenged by regulation and a regulatory environment which looks like it may become much firmer.
We have seen a rent cap imposed in Berlin and one of the challenges we will see there is that product quality may start to decrease significantly. If people are not allowed to increase their rents then there is no incentive for them to improve, or perhaps even maintain, the quality of their property.
How will the covid-19 pandemic and the associated economic slowdown affect the market?
This is probably the largest social experiment we’ve ever done. We’ve never seen 100 percent of people suddenly working from home. This does have a lot of impact potentially on how we look at residential.
The obvious one that I think a lot of people are considering is: “Do I want to pay for my one-bed flat that is centrally located, or do I want to move out to the suburbs and have two, two-and-a-half bedrooms with some outdoor space?” We are seeing hedge funds trying to work this trend in the US and bidding up house builders who are building in suburbia. I think this will be a big trend in the short term, but it remains to be seen if it is a permanent change.
The other significant trend is that people have suddenly needed to create a professional workspace at home. I think there will have to be a rethinking of space, and I foresee space being required for professional workstations. We may see multifamily being advertised as two-bedroom, two-workstation flats, for example.
In London and other large cities, the desirability of an apartment is closely related to its proximity to public transport. But now public transport is being seen as a risk and the government is trying to dissuade people from using it. With different transport priorities will come different location demands.
It seems to me that the global megapolis is losing its luster. Cities such as New York have been at the epicenter of the pandemic and this makes them less desirable. If you are young and single, the value of living downtown will continue, but others may consider living further out and perhaps renting a small pod for overnight stays when they are working in the CBD office – a sort of 21st century pied a terre. It is not that everyone will change from living one way to another, but that there will be changes in demand at the margins and 10-20 percent of people looking for a change is a big market.
The other major challenge is that an economic downturn will hit incomes, and that affects the ability of people to pay rent. So even if land prices fall, affordability will remain a challenge.
What should investors in multifamily be addressing in light of these potential changes in demand?
The big call to make is on location. Are those locations where the main attraction is proximity to a transport node going to remain the focus of demand? Or do you need to look at locations within electric bicycle distance of the CBD, even if they lack a metro link?
The pandemic has brought a new focus on sustainability. We have breathed clean air for a couple of months and that has encouraged cities – take London for example – to accelerate clean transport initiatives. How will residential supply adapt to meet the needs of these new green commuters?
I think people will think more about wellness, so air quality within a unit will be more important. Creating air filtration systems that make people more comfortable about the air they breathe will be necessary; renters are going to start asking questions about air quality when they are deciding where to live.
The key macro takeaway is that residential as an asset class in Europe has to grow up, it has to institutionalize, and you will need both developers and investors who live and breathe the product going forward because I think one of the things people underestimate overall is how asset management-intensive this asset class is. So many people like the idea of owning residential but do not realize how difficult it is to manage on a day-to-day basis or how difficult it is to create a good product.
How significant is ESG for multifamily investors?
In the longer term, ESG will become important for all investors, not
just progressive institutions. High-net-worth investors will care as much as
Dutch pension funds. So, if you invest now in sustainability, not only will
you reap cost savings over time, but your assets will be more marketable in
five years’ time.
I sense there is a very significant shift, and hence, even though many of
these investments may not show a return within a one- or two-year period,
I think they are good investments because you will be on the right side of
history, so to speak, and rewarded when you come to sell.
What role will technology play in the future of multifamily residential?
Technology will be at the heart of how we make residential real estate more sustainable. The built environment accounts for 39 percent of global emissions, yet we haven’t been reducing our carbon footprint and have escaped relatively lightly with regard to the tax and regulatory burden thus far.
We have been probably the last of all industries to adopt technology. I’ve been excited about the opportunity within technology because I think we are finally at that adoption point, and in the spirit of never letting a good recession go to waste, I hope this pandemic will accelerate our adoption of tech as an industry going forward.
We are going to see huge demand for – and a real focus on – the provision of high-speed fiber in residential buildings. As more people work from home, they need fast broadband to run videoconferencing and other business software. Lack of it will be a deal breaker in the future.
We also need to look at the construction side of the business, which is very wasteful at present. I think that residential lends itself very well to modular building, which allows for significant reduction in waste on construction sites and also allows for everything from better insulation to better quality control.
People have thought of residential as an uncomplicated product: four walls, two beds and we are good to go! That will change significantly as tenants demand flexible space, which can be adapted for work or leisure, and changes to construction will be needed.
On the management side, technology can be used to smooth the relationship between landlord and tenant. An app which automatically links tenants with an approved plumber can save a lot of management time and thus save money. It is scalable and makes for a better user experience. On the leasing side, technology allows landlords to offer different lease lengths; Airbnb is the classic example of this. In a downturn, being able to offer maximum flexibility will be important to tenants and lead to better-leased buildings.
The Internet of Things is also going to play a major role. Today, landlords rely on tenants to alert them to problems, but sensors can do this quickly and efficiently. IoT sensors can make changes to lighting, heating or air-conditioning, which will make the asset run more smoothly and cost-efficiently. Across a portfolio, the savings could be substantial. Something important about all of these technologies is that they can be retrofitted very easily; you don’t need to tear an asset down, and of course retrofitting is more sustainable.
I believe these changes in demand and technology will come together to make for a much more rounded service offer to tenants. There will be a more fluid relationship between landlord and tenant and a wider range of services offered. The pandemic has been a catalyst for these changes but it is technology that will be at the heart of a more grown up multifamily sector.