The events of the past year have sharpened the focus on residential investment in the UK. As an alternative asset class, the sector is rapidly evolving and until now has proved an attractive investment. But the government has rental reform high on its agenda and is committed to what it sees as a better deal for renters in England. The government had already committed to abolishing ground rents for long leases and seems equally intent on doing away with assured shorthold tenancies, the mainstay of the private rented sector. What might replace them (and what that might mean for investors in the sector) remains to be seen.
In the autumn of this year, the government will publish a White Paper detailing its proposals for a reform package. If these proposals are considered too tenant friendly, investors may increasingly look for opportunities to invest outside of the UK. What might they find?
France
With €5.5 billion invested in France in 2020 (a 41% increase on 2019), residential real estate is a growth sector for two main reasons: (i) a widespread lack of housing and (ii) tax incentives created by the government to encourage investment in the sector.
Property investment can be through direct ownership or indirectly via specific vehicles to facilitate collective investment (notably OPCI or French REITs). Direct ownership requires a notarial deed to be entered into which is registered at the land registry. Similar to the UK, indirect ownership is achieved through share purchase.
Residential leases are heavily regulated by law and are very tenant friendly, including rent capping in some cases. This is sometimes considered to be a barrier to investment in the residential sector. That said, despite measures implemented by the French government to cap rents in major cities such as Paris, rents in France are still increasing although less rapidly than previously. Profitability of the investment is assisted by tax incentives but also by the potential avoidance of rent caps (to some extent) by carrying out renovation works.
Investment in the social residential sector is also an option. Often disregarded because of the strict rent caps, these properties are usually less expensive. In addition, due to the lack of social housing in France, investors may benefit from generous government incentives including additional tax incentives, government grants for works and rent guarantees.
Germany
The private rented sector in Germany presents many opportunities for foreign investors. Only about one third of Germans living in cities own their own homes. Investment can be through direct ownership or indirectly via the stock market in listed housing companies. For foreign investors, the market offers stable macroeconomics, expanding cities, close to zero interest rates in an extremely competitive banking market and balanced relations with residential tenants.
Additionally, Germany has seen escalating rent increases and spiralling house prices in the big cities over recent years due to a growing population, limited housing supply and lower residential development activity than expected.
Acquisition of residential property is relatively straightforward. All purchase agreements need to be signed before a public notary. Land registration is very reliable and there are no investment restrictions for foreign investors, nor any clawback for capital gains made.
As Germany is a country of tenants, tenant organisations are well represented in the political arena. Nearly all federal and state governments have regulated the sector quite heavily. Rent increases are capped in existing tenancies and rents in new tenancies are required to be within a specific range in the big cities. Since 2020, additional teeth have been added to these restrictions, with tenants entitled to claim a reimbursement of rent if rental caps are breached. In addition, tenant organisations can bring class actions in cases of systematic overrenting. Landlords can terminate rental agreements only in limited circumstances. Investors therefore need to carry out careful due diligence on rent levels, recoverability of service charges and potential disputes.
Italy
Italy is traditionally a country of homeowners, with more than 75% of the population owning their own home. Until recently, the apartment rental sector was largely limited to students and those requiring flexibility for work reasons.
However, things are changing rapidly, especially in big cities. The change is mostly driven by a new generation who are accustomed to moving for study and work reasons and who are less keen to commit to life-long financing to buy a home.
This is driving an increase in institutional investors in the residential sector, offering new-concept houses with a high degree of energy efficiency and often located in new residential districts with parks, services, and other conveniences. The same trend applies to new residential products such as co-living and senior living where demand is also growing, especially in large cities.
A number of international investors have recently completed large deals in the residential sector in cities like Milan. The focus is not only on high value properties, but also on new developments of medium-priced housing.
In Italy there are no restrictions on the purchase of real estate assets by foreign investors. Acquisitions can be made through an asset purchase or through the acquisition of the shares in the asset-owning corporate vehicle. The transfer of the asset occurs upon execution of the transfer deed which must be made in writing and authenticated by a public notary and then filed at the land registry.
The legal framework for residential leases is quite fragmented (i.e. different regulations may apply depending on the specific residential needs and varies in different regions) but legislation is generally pro-tenant.
Poland
It is estimated that Poland has a shortfall of around 600,000 apartments, with about 1.7 million people in need of a suitable apartment. An average monthly salary allows for the acquisition of one square metre of apartment, which is half of that in “old” EU countries. Around 85% of individuals live in their own – often too small - apartments and only 15% live in rented accommodation.
It is therefore no surprise that in recent years, large Polish residential developers have been acquired by private equity investors.
While the Polish residential market relies mainly on the sale of commonhold units by developers to individuals, the market for investment in rental apartments is growing. In 2017 German Catella acquired 72 apartments for rent in a landmark Libeskind designed building. Since then, and as recently as May 2021, there have been a number of bulk acquisitions of apartment blocks, which have attracted a number of large players in this field, such as Resi4Rent, LC/Vonder and Swedish company Heimstaden.
Rental levels are market-driven with few limitations placed on the private rental sector. The tenancy agreement regulates rental uplifts and offers an accelerated eviction procedure. Additionally, leases are signed for a fixed term with no automatic right of extension.
Acquisition of residential property is straightforward. Land registration is reliable and the purchase agreements are signed before a public notary. There are no investment restrictions for EU investors, regardless of the domicile of their shareholders.
Spain
Before COVID-19, Spain was the second most-visited country in the world after France. From its food and climate to its vibrant cities, culture and history, there are many reasons why people buy property Spain. These attractions are a key driver for a significant second homes market, although given that the UK made up a significant part of that market, the impact of Brexit remains to be seen. Spain has traditionally been a country of homeowners, but this has changed in the last years, particularly post-financial crisis.
The residential market in Spain has no restrictions for foreign investors, and purchases can be structured via an asset or share deal. The Build to Rent and Private Rented sectors are booming and they are mainly dominated by investment funds structuring purchases through SOCIMI vehicles (Spanish REITs).
One of the greatest challenges for this sector are rent controls and government intervention in rental prices. Recently, the government of Catalonia implemented restrictions on rent increases for permanent dwellings, although this decision has been appealed in the Spanish Constitutional Court and the outcome is awaited. Under this new regulation, if the landlord is a company, the initial rent cannot exceed the reference price for the lease of a residential unit of similar characteristics in the same urban area. The same principle applies if the landlord is an individual, with some exceptions. The reference price will be established by the regional government. Another challenge is the taxation of empty dwelling portfolios owned by large property owners and implemented by the Catalonian and Basque governments.
There are however tax incentives for entities engaged in residential leasing. The purchase of newly built residential homes is subject to a super-reduced 4% rate, provided that the asset meets tenure requirements and there is 85% tax relief on standard corporate income tax on net income from residential leasing.
US
The residential sector in the US weathered 2020 better than most other property sectors, with an expected full market recovery in early 2022. This recovery will be mostly attributed to job opportunities providing more financial flexibility to the high volume of young adult renters. Forecasters are predicting a return to pre-COVID vacancy levels and a 6% increase in net effective rents later this year.
The COVID induced recession impacted urban submarkets much more than suburban submarkets. Factors which detrimentally impacted the previously robust urban multi-family submarket included remote working, the closing of urban amenities, a limitation on public transit and a desire for more living space and access to the outdoors. Millennials are also beginning to eschew high rise urban living for larger housing options in less-dense submarkets. While this decline in urban multi-family demand is likely not permanent, there is no doubt that the short term recovery will be led by lower-density and less-expensive suburban submarkets.
With steady improvement in the market conditions, multi-family investment volume is expected to increase in 2021. Institutional investors and value-add investors are likely to become much more active next year as the predictability of future revenue streams becomes more clear. Offshore buyers will also likely increase their activity, especially as travel restrictions are eased. A continuation of low mortgage interest rates will provide further incentive for increased investment.
With all of that said, the largest near- term issues facing investment into the US residential sector are the impact of various federal, state, and local eviction moratoriums, as well as the impending expiration of various rental and mortgage forbearance programs. Many jurisdictions have also imposed rent forbearance programs alongside these moratoriums. Investors will likely wish to closely observe federal and state legislative developments over the next few months, as it will be difficult to value the short-term investment potential and rental streams of residential assets until this COVID-driven regulatory framework expires.
An earlier version of this article appeared in Estates Gazette on 3 July 2021
Authored by: Paul Tonkin, Jane Dockeray, Michael Levy, Margot Derumaux, Roland Bomhard, Marco Rota Candiani, Marek Grodek, Bartosz Clemenz, Emilio Gomez, Lea Ann Fowler and Ingrid Stables.
