Rental housing shows resilience

No sector has totally escaped the impact of last year’s sharp rise in interest rates, but rental residential property remains a popular choice with investors due to its historic resilience and substantial undersupply in many markets around the world. Investors have continued to support residential strategies, with a natural leaning toward the US, the largest rental housing market.

Multifamily and single-family rental are less developed sectors in other markets but are still attracting capital. Last year, residential specialist Greystar raised €1.55 billion for its pan-­European fund, while Hines and Cadillac Fairview raised A$1.5 billion ($1.01 billion; €918 million) for a single-family build-to-rent strategy.

PERE data shows a total of $33.55 billion of capital raised for residential funds in 2022, more than the $31.51 billion raised in 2021 and a new annual record. The overwhelming majority (70 percent) of the capital raised for sector-specific residential funds was allocated to North American funds, a natural consequence of the US being the world’s largest multifamily and rental residential market. Asia-­Pacific-focused sector-specific funds raised 20 percent of the total, well above the five-year average, boosted by the Hines and Cadillac Fairview fundraising.

There is also appetite for residential outside the sector specialist funds. Blackstone Group recently closed its latest global real estate fund with $30.4 billion of total capital commitments and describes rental housing as one of its “highest conviction themes.”

MSCI Real Assets data shows a similar pattern in residential transactions worldwide, which hit a record $471 billion in 2021 before falling back to $364 billion last year, which was nevertheless still much higher than all preceding years except 2021. Investors turned to more resilient sectors such as residential during the pandemic and – in most developed markets – residential prices continued to rise until the second half of the year, when interest rates rose rapidly in the US and then most other large economies. 

Jennifer Ciullo, global head of investor relations at Greystar, says: “Rental housing has delivered the highest risk-adjusted returns with the lowest volatility of any other major real estate class. Today, it represents one of the largest percentages of real estate holdings within most institutional capital portfolios.

“In our view, multifamily is still one of the most popular investment opportunities as a highly liquid residential type, followed by student housing and senior living thanks to their counter cyclical nature.”

Wait-and-see approach

Nonetheless, nearly a year of geopolitical and economic upheaval is making investors more cautious today than they were a year ago. David Reynolds, president of investment management at Boca Raton-based Mill Creek Residential, says: “There is a tremendous amount of capital out there interested in investing in residential rental communities. However, they don’t have the same appetite today that they had in recent years, so they are keeping their powder dry. 

“Most of the investors with whom we speak are interested long-term in increasing their investments in the residential rental sectors but are taking a wait-and-see position until there is more clarity on the overall state of the economy. They are looking for clarity on whether there will be a recession and what its impact will be; when inflation will be under control; when the yield curve will return to normal; and what the long-term prospect is for cap rates.”

Jasper Gilbey, head of housing, alternatives and strategic transactions, Europe at Nuveen Real Estate, says: “A lot of investors are taking the wait-and-see approach, they want to see price discovery play through before re-entering the market.”

Prices for residential of all kinds have been hit by rising interest rates. A Reuters survey of economists predicted price falls (from peak to trough) ranging from 8 percent in the UK and 10 percent in the US to 16 percent in Australia and 20 percent in Canada for owner-occupied homes. 

The effect of rising interest rates on rental housing has also been varied, says Gilbey. “There has been a lot of variation between different European markets – and equally across different residential subsectors – but broadly we have seen 50-100-plus basis points expansion in yields. 

“We have seen the biggest impact in many of the core markets (such as Germany) where prime yields had reached levels well below 3 percent – buoyed buy cheap all-in financing rates around 1.5 percent. 

“Now, we are starting to see equity buyers re-enter in core markets and getting comfortable with yields around the 4 percent mark – a meaningful expansion from yield levels at the beginning of 2022.”

The picture is not dissimilar in the US, says Reynolds. “Overall values for multifamily assets have definitely dropped. However, it is difficult to say by how much, as there has been very little in the way of price discovery. 

“The only people who are selling today are those who need liquidity due to redemptions or distress caused by exposure to other out-of-favor asset classes. 

“Today, with limited sales data available, we would estimate the cap rates on Class-A multifamily assets to be around 4.75 percent. We expect cap rates will decline from their levels today, but not to the levels of the first half of 2022. We would expect them to settle in the plus or minus 4.25 percent range.”

Undersupply and demand

The key factor which supports owners of multifamily, single-family or other rental residential subsectors is strong operating performance, which has been driven by an undersupply of rental housing in most developed markets and the high cost of buying a home. For-sale property prices have risen far faster than incomes in most cities worldwide.

Gilbey says: “On the occupational side, we have continued to see strong demand driving high occupancy and attractive rental growth across our student housing portfolio on the continent. We have seen the same dynamic across our single-family rental platform in Denmark, with a combination of high occupancy, very minimal tenant churn and quick re-leasing at a rental premium.

“The bulk of our multifamily housing exposure is currently in Spain via a joint venture with Kronos and their operating platform, Stay. Our first asset was delivered last year in Tarragona, 100 percent pre-let and at a double-digit premium to our underwritten rents.”

Reynolds concurs: “Our portfolio continues to perform well in 2023, with lease percentage and occupancy rates for our stabilized portfolio above their five-year averages. Rents also continue to be strong; we are 7.5 percent ahead of last year on like for like rents.”

Housing affordability is a problem in cities all across the world, with home prices increasing significantly faster than incomes. Meanwhile, the rise of single-person households has also increased demand for homes. Recent falls in house prices have provided little comfort for buyers, as mortgage rates have doubled in many markets. 

Meanwhile, demand for rental housing outweighs supply. Nadeem Meghji, head of Blackstone Real Estate Americas, says: “In the US, there has been an undersupply of 4 million homes since the financial crisis. Additionally, housing permits are down 25 percent from last year because of higher construction costs and limited credit availability so we expect the supply/demand imbalance to persist.”

There are signs that the cycle of interest rises is coming to an end, which is expected to reassure investors, even if substantial rate cuts do not materialize. Both the US and Europe have maintained employment numbers, supporting both for-sale and rental residential. 

Mill Creek’s Reynolds says: “Our view is that any recession will be mild given the strength of the labor markets, and the Fed is close to finished raising interest rates. 

“Further, the US is close to getting inflation under control, and supply chain issues are moderating. As a result, we expect costs to be flat-to-down over the next few years, after a nearly 40 percent rise since the beginning of covid.”

Furthermore, for investors in the residential sector, much of its appeal is down to underlying drivers and its long-term resilience across market cycles, with a perennial undersupply of homes only exacerbated by recent inflationary pressures’ impact on construction costs.

Ciullo says: “With rental residential underpinned by strong demographic trends and a strong value proposition, we expect multifamily, student housing and senior living to continue to be amongst the best performing ­sectors.”

Everyone wants to be big in Japan

Japanese multifamily residential has been a favorite for international investors in recent years and there are few signs of falling demand.

The sector’s stability, coupled with almost static interest rates and a rare positive yield gap, make it attractive to core real estate investors. Managers including AXA IM Alts, Blackstone, Greystar, M&G Real Estate, Nuveen Real Estate, Pimco Prime Real Estate and Savills Investment Management have targeted the sector in the past decade. 

New investors keep joining the fray. In December, Hines made its first Japanese multifamily investment, buying 11 properties in Tokyo, Nagoya and Fukuoka. The company said it intends to build a $1 billion portfolio.

After a drop-off during the pandemic, the population of Tokyo’s 23 wards has begun to grow again, with the return of expat workers. Japan’s larger cities keep adding to their population, even as Japan’s overall population declines, due to younger people seeking jobs and lifestyle opportunities. While borrowing costs and yields have risen slightly in the past year, as Japan has seen some imported inflation, a gap between borrowing costs and yield remains. This positive yield gap, which drove so much real estate investment after the global financial crisis, is now unique to Japan, so investors will continue to allocate capital there.