PATRIZIA: Rental takes center stage

A confluence of factors is making the asset class particularly attractive to long-term investors, says PATRIZIA’s Marcus Cieleback.

This article is sponsored by PATRIZIA.

Pressures in the European residential sector have only compounded the affordability conundrum in recent years. Not enough supply, strong demand and urbanization trends – not to mention the pandemic and ongoing financial downturn – are the main factors making home ownership more unobtainable for the younger generation than ever before.

Expectations across Europe are also changing, and various demographics are being forced to depend on rental markets for longer than at any other time in recent memory. Whether the dynamic forces more action from governments remains to be seen, but clearly there are strong tailwinds for the residential rental sector and particularly the affordable end of the housing spectrum. Marcus Cieleback, chief urban economist at PATRIZIA, examines the forces shaping the asset class. 

How are interest rates and inflation affecting Europe’s residential sector? 

Construction is becoming ever more expensive for developers to finance. We have already seen some projects postponed or scrapped as they are no longer economic to develop. From that perspective, it is affecting future supply.

Rising interest rates also mean it is harder for first-time buyers to get on the housing ladder. Many people will be forced to stay in rented accommodation for even longer than expected.

Combined, we have a marked imbalance between demand and supply on the for-sale side and increasing demand on the rental side. Overall, this trend supports the fundamentals of the multifamily sector. 

On the inflation side, like interest rates, high inflation is increasing costs for raw materials and construction. Labor is also getting more expensive.

Similarly, people have less money to spend on mortgages, so it is affecting the ability to get on the property ladder and reducing purchasing power to cover increased rental bills. Combined, the economic backdrop means affordability is taking center stage in discussions about market perspectives. 

How will rental regulations impact the market? 

Rental regulations have always been a feature of mature markets. From an economic standpoint, these are the rules of the game and if you want to play then you have to accept them.

The important point is that we are now seeing changes to rental regulations due to challenges like affordability, environmental concerns and so on. As a real estate investor, you simply have to adapt and accept that if you want to participate you have to follow the rules. 

The biggest challenge is staying ahead of the game by closely monitoring, on a continuous basis, developments taking place on the ground. What we do with our local teams is to try to identify political initiatives and understand what these might mean for our business aims. We have to think about whether they will change our current plans or potential future plans. 

This means investors need to be much closer to the action to fully understand what is happening. As a caveat, it is not something that people should be afraid of, as overall regulations offer benefits and greater predictability. If you have rental regulations, you know that there is a strong market because why else should the government care about rental regulations if it is not already sizable? It is a good indicator of a more mature market. 

How is the affordability push shaping the dynamic? 

The affordable housing segment is an asset class where investors can make a big impact. The biggest challenge is defining what really classifies as affordable. How do we define and measure that?

This is something that investors are struggling with as there is no uniform understanding or definition. From the legal side, we might say that 10 percent below market rent is deemed affordable, whereas from an economic point of view this definition does not look at the income of tenants and is therefore missing a crucial element of affordability, the income side of a household.

There is obviously complexity and differing viewpoints, but investors are keenly looking at the asset class. It is something where you can be sure demand is rock solid. You have a stable income stream and often a quasi-government income stream that gives you the security that investors are looking for.

Governments realize that they have a duty to provide supply but cannot do it entirely on their own. Rising costs and land prices present a challenge, which will not make it easy, but there is awareness that private capital will need to play a significant role. 

What are some of the other mega-trends shaping the residential asset class?

Over the past three to five years, we’ve seen a reassessment of renting among younger people. If you look at households in their 20s, 30s and 40s, it is becoming an accepted part of life that they will not be able to get on the housing ladder at the early stages of their career.

People are not giving up the dream of owning their own home but realize they do not yet have the income levels and will have to wait. As an investor, you therefore have an attractive rental base of people in their 20s and 30s who have good jobs and stable income.

Another trend is urbanization. During the pandemic, we often heard stories about people moving to the countryside but if you take the long-term perspective there will not be a fundamental change from urbanization.

If you look around the globe, cities are still the place where there are the best opportunities, the greatest innovation and the best available jobs. Whether you are a CEO or moving from lower pay to a higher-paid job, the result is that people are looking to the cities.

Of course, the risk and dangers of pricing people out of cities is very real. Urban centers need labor across the entire pyramid: from low skilled to people with the highest income and skill sets. Lower skilled people need to be able to live within city limits, with access to good infrastructure. 

And again, this links back to affordability. Cities need police officers, nurses and teachers to function properly. Recently we saw the strikes in Paris, and the affordability challenge is something that governments and cities need to directly address. 

Where do you see the most attractive opportunities developing? 

At a time of crisis, student housing always offers protection as people look to invest in education. The demand is always there. Single-family rental really boomed in the US after the global financial crisis, and while we do not have a US-type market in Europe, we think it is a niche that is likely to experience growth.

Alternatives linked to multifamily are also worth looking at. The whole rental chain, including co-living, is a market that may be small and possibly declined a little recently but will return in the coming years. 

What are some of the main challenges ahead? 

We need a pragmatic operating environment with co-operation throughout the sector to address the affordability challenge and increase building activity. The residential market as a whole is a very slow-moving beast; the consequences of our present actions will not be immediately visible but may take several years to materialize. This means we need governments to act together toward a common goal. Of course, the problem is that if you implement today then the next government might reap the rewards. Short-termism is a big problem for many industries but particularly real estate.

We need not only the government but the opposition to agree on long-term targets. It is not rocket science, but there needs to be some cross-party lines or activities to address the problem. Again, this is not easy in the current political environment.

Often people also think that regulations are the easy solution to a very complex question, which is simply not the case. We have to explain that the market is far more complicated and requires a nuanced approach.

How is the sustainability and ESG conversation influencing the asset class?

We cannot ignore climate change or carbon emissions. As a sector, we must recognize that addressing the environmental impact comes with a price tag; if you improve a building, retrofit a home or change the heating system, then someone has to pay for that.

Crucially, this can conflict with the social goals of ESG. There is a tension between the S and E in the residential sector. I do not have the solution yet, but the E element means rising costs, while the S element means you cannot raise rents simply to finance all of this as it exacerbates the affordability problem.

It is encouraging, at least, that governments have set clear goals, as the sector has not been the fastest mover in recent years. Governments need to set clear guidelines going forward to keep the industry in check and moving forward.

At the same time, the authorities need to provide support, so that we do not compromise either the social or environment elements. If we do not have broad acceptance from the population, we will ultimately fail on both fronts, which is not something that anyone wants to see.