One market seems to completely defy the efficient market theory. For decades, around the world, strong demand for housing has been met by inadequate supply. An efficient market would fill this gap. But market solutions do not always match societies’ objectives.
The use of private capital to finance housing is often controversial, but it is also essential. With demand outstripping supply, housing affordability has worsened in most major cities. As a result, there is a widening wealth gap between home owners and the rest of society.
Today, investors can find growing opportunities to provide solutions. Their capital will assist people who cannot, or choose not to, own their own accommodation.
In this paper, we set out the investment opportunity. There is a need to finance residential assets suitable for every stage of life from cradle to grave. We call this real estate for ‘living’.
Next, we study the long-term return characteristics of the asset class. These markets offer relatively stable income streams, linked to inflation. We set out the structural drivers of growth, as well as the hurdles to achieving these returns.
We finish by explaining how active management can improve returns. We explain why investors should look for ‘AAA’ assets – accessible, affordable and near amenities. We set out why happy tenants make for happy landlords.
Policymakers and the private sector will need to work together to address the shortage of social housing. We set out the issues that have prevented progress and offer some solutions.
Tackling the lack of affordable housing is possibly the greatest challenge for providers of real estate. Yet investors often overlook the diverse market in real estate for living. They shouldn’t. Meeting this challenge offers the potential for attractive rewards. This paper provides a practical guide to identifying these opportunities.
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Institutional capital and the
global rental communities
A diverse set of opportunities
The United Nations estimates that some two-thirds of the world’s population will be living in cities or other densely populated urban areas by 2050.1 Cities around the world will continue to gain in importance. Rapid urbanisation and increasing affluence are shifting the scales of economic power in their favour.
Living assets offer attractive investment characteristics to income-oriented investors. Cashflows are secure, often inflation-linked, and therefore predictable
However, the opportunity for most people to live in the most popular cities and to contribute to those economies has become more challenging. Prices have surged as housing supply falls short of global demand.2
But chronic supply shortages can also present an opportunity for global investors. It is attracting investor capital seeking low-risk, income-producing assets which can be developed at scale. Markets previously closed to private capital allocations are rapidly opening up.
In fact, our 2019 survey of investor sentiment towards the ‘living’ sectors supports this observation. The study found that some 79% of those surveyed were looking to increase their exposure over the next five years.3
Living assets are property designed as rental assets for residential purposes, providing accommodation for all ages. Assets include student housing, private rented accommodation, affordable housing and healthcare facilities.
This asset class is growing up. In more mature living markets, specialist needs-based properties are being built out rapidly and at scale. That said, investment opportunities in living sectors are still nascent in many countries.
Many markets have become more receptive to institutional capital, creating a rapidly expanding set of investment opportunities.4 Furthermore, management skills, operational information and investment confidence are crossing borders, further widening the scope of opportunity.
Scale capital – investments of a size that’s appropriate for institutional investors – is being deployed. It is used to develop specialist rental accommodation designed for the needs of the young and the old, as well as the many stages of life in-between.
The classification of living sectors is important as investors must recognise the different investment opportunities and their characteristics (see Chart 1). Living sectors offer a wider variation of operational models meaning investors can adopt passive or active approaches to their investments.
Chart 1: Global living encompasses a rapidly expanding opportunity setSource: Aberdeen Standard Investments, October 2019.
‘Hands on’ operational management
Living assets have evolved beyond the traditional model of simply leasing an asset to a tenant. ‘Hands on’ operational management of the asset can drive efficiencies and enhance the total return from a building.
For example, a landlord who leases out a block of purpose-built student accommodation (PBSA) only receives the fixed contractual income from the lease agreement. This is a more passive approach to investing. The landlord passes up on operational gains that could be made from running the asset directly.
Taking on operational management of the asset means the return profile becomes linked to the direct earnings from managing the property. The risk-reward profile increases as the landlord is exposed to increased volatility in earnings. In other words, he or she stands to gain (or lose) from any earnings above (or below) the agreed lease on the asset.
In most cases, assuming the operation is a going concern, earnings should be in excess of a lease secured on the asset. Supply restrictions are supporting rental values and investor incomes. This is a key consideration during the due diligence process ahead of acquisition.
Living assets come with varying degrees of operational intensity and complexity. They deliver a range of risks and rewards that are associated with different specialist businesses, such as healthcare or assisted living.
For example, in the case of student accommodation, investors can simply lease the building to a third-party operator (low operational intensity). Alternatively, they can take a more direct role in designing and managing the building (higher operational intensity).
Typically, most living assets will be a variation of the same basic rental business model. The only differences are additional management or operational twists that are becoming more transparent, as well as easier to understand.
Global demand-and-supply imbalance
Prolonged shortages of goods and services in a market economy are rare. Companies can influence their supply chains to increase production volumes when demand changes. New entrants to market can influence aggregate industry supply.
However, the story is quite different for the pipeline of new housing. Housing supply struggles to react quickly to sudden, volatile changes in demand.5
Building new homes takes time, sometimes many years for complex or large projects. Local authorities need to approve all new greenfield (completely undeveloped) and / or brownfield (partially undeveloped) sites. They also have the final say over whether or not to reduce supply by demolishing vacant buildings or converting them for alternative use.
Meanwhile, the volatility of the property cycle dissuades homebuilders from increasing supply when prices are falling, but persuades them to increase supply if prices rise. This never results in market efficiency.
Housing developers are more focused on profit-maximisation, less on fulfilling pent-up demand. Separately, speculators in markets such as the UK have come under fire. Some have been accumulating sites that are left undeveloped until they can be sold for a big profit – a practice known as ‘land banking’.
In Europe, new-built houses typically represent less than 0.5% of total housing stock. At current rates, this implies new-built stock has to last for at least 200 years to replenish and replace existing supply. There is also the question of whether housing stock built in the last century is fit-for-purpose. Does it meet the needs of residents, or modern expectations in terms of unit size, design and energy efficiency? Typically, we suggest, it doesn’t.
Since the global financial crisis, housing supply in major global cities has struggled to keep pace with strong demand. The supply pipeline continues to underserve global markets and the cumulative shortfall of housing is getting wider. Restrictions on bank financing, planning constraints and rising construction costs only complicate matters.6
Living sector-asset supply is, as a result, very capacity-constrained. In Tokyo, for example, supply has remained relatively static for the better part of a decade. Starts – construction commencement – of new housing units continue to trail the rate of average household formations per annum. This results in a greater cumulative shortfall each year (see Chart 2).
Chart 2: Housing starts are not keeping pace with demand
Start vs change in households - TokyoSource: Nippon Accomodation Fund, United Nations, October 2018.
Start vs change in households - United StatesSource: National Statistics Agencies, Aberdeen Standard Investments, October 2018.
The position in the United States seems more positive in aggregate. A steadily increasing supply pipeline has not only recovered since the global financial crisis, but has even expanded. It now looks sufficient to meet annual demand for housing stock. That said, we still expect localised, largely urban, shortages to persist. A bigger pipeline of new housing units, over and above annual demand levels, will be needed to correct existing supply shortages.7
Institutional investors are often punching below their weight in the living / residential investment world. A market share comparison of regional real estate indices suggests that representation of this asset class around the globe is typically low and inconsistent (see Chart 3).
Chart 3: Institutional allocations to living sectors are low and inconsistentSource: MSCI, Aberdeen Standard Investments, April 2019.
Select European markets and the US are better established – where institutional investors deploy substantially greater investment – with regards to living assets. The Netherlands, for example, boasts a large and diverse supply of affordable housing. Finland and the US provide many multi-family / private rented sector apartment blocks.
However, most established commercial real estate markets exhibit a severe underinvestment in living sectors. Investor focus has traditionally been on allocating to commercial real estate, and living sectors have typically suffered from a lack of institutional capital. In fact, many developed economies have very limited or nascent institutional markets.
It is notable that private investment in rental housing is often widespread where institutional investment is not (e.g. UK, Italy, Australia, central and eastern Europe). Investment is significantly influenced by national tax policies that affect private investors.
In the UK, transfer tax hikes and income tax changes have reduced the appeal of the ‘buy- to-let’ market for smaller private investors.
Clumsy regulation can limit investor appetite. Rules need to be fair and balanced. But the ‘industrialisation’ of housing supply and management can work in harmony with the goals of public policy. Best-in-class operating models can easily be transferred across borders, and these will boost the confidence of residents, policymakers and ultimately investors. This is a potential win-win-win for everyone.
Access an attractive set of risk-return characteristics
Living assets offer attractive investment characteristics to income-oriented investors. Cashflows are secure, often inflation-linked, and therefore predictable. In many cases, risk is reduced because properties are occupied by a diverse tenant base, rather than due to a strong financial covenant. The breadth and size of a varied tenant base provide significant diversity and can materially mitigate risk.
There are riskier real estate strategies in the living sectors. Some involve more speculation over the development and stabilisation of new properties. Risks associated with land acquisition, re-zoning, development and maturing of assets are unlikely to meet the requirements of most conservative investors.
However, there is strong and growing requirement for completed projects from both occupiers and more risk-averse investors. Those investors who are able to commit to higher-risk, higher-return living strategies should gain confidence, regardless of whether they plan to hold onto their investment or exit. This may be in the form of strategies where assets are designed and developed with wholesale rental in mind.
The investment performance of commercial real estate assets tends to track the business cycle. On the other hand, living assets are affected more by longer-term factors – population growth, employment growth and rising affluence. These exhibit a weaker correlation with the ups and downs of the economic cycle. This makes investing in living assets a good way to diversify an investor’s portfolio.8
Long-term drivers, more structural than cyclical, lead to a more stable income profile. Consider an apartment block of private rented sector accommodation where rent is collected from a large group of tenants on short-term tenancy contracts. Frequent breaks in leases mean the rental growth for the building closely tracks the market rate.
Short-term leases allow for any income to converge with the going market rate and adjust quickly to reflect price rises in the economy. In most cases, they’re inflation-linked not through any contractual element, but because they reflect the prevailing excess of demand over supply.
Investors should consider the optimal living asset size (i.e. number of apartments). A diverse spread of underlying tenants will smooth out potential breaks in the income stream by an individual occupant. This, in our experience, creates economic efficiencies for operational management.
The key to effectively managing these assets and to drive operational efficiency is a balancing act. Investors must try to maximise income growth potential, while managing vacancy levels. Aggressive rent hikes can alienate tenants and encourage them to vacate their residences.
The cost of voids – empty units – and replacing tenants can be detrimental to returns. Our earlier paper, ‘Happy Tenants = Happy Landlords’9 showed that tenant retention is an important driver of more efficient property management.
Different living sectors come with varying levels of tenant turnover. For example, hotel guests occupy their residences for just a few days. On the other hand, university students may only vacate their residences during the holidays between terms. But different levels of tenant turnover do not necessarily point to increases in vacancy rates or a more undesirable investment thesis (see Chart 4).
Chart 4: Private rented sector accommodation should be the centrepiece of any living strategySource: Aberdeen Standard Investments, October 2019.
Effective management of living assets can secure a stable stream of income with strong potential for rental increases. It can ensure residences are quickly re-let upon lease expiry and that occupancy rates are maximised. Looking after the asset and making sure it has ongoing appeal to tenants can further enhance the income profile.
The scale at which these assets need to be supplied is considerable. This is especially the case for private rented sector accommodation, affordable housing, and retirement rentals for the elderly. Development of such assets is subdued throughout Europe (averaging less than 0.5% of existing stock per annum)10.
Living assets offer attractive investment characteristics to income-oriented investors. Cashflows are secure, often inflation-linked, and therefore predictable
Long-term drivers of investment
Stable returns, low risk, with inflation-matching characteristics
Income generated by living assets has historically provided consistent income growth that can provide inflation protection11. This is due to the stable and predictable long-term drivers of the asset class.
Occupant demand for living assets has been much less variable compared to commercial real estate properties.
Evidence suggests that occupant demand for living assets has been much less variable, especially compared to the demand for space in commercial real estate properties. And it will be for years to come.
The income profile of the office sector, for example, is cyclical. It moves in tandem with the strength of the underlying economy.
Companies look to take on staff, grow their businesses and rent more space when the economy is growing fast. They tend to cut costs by laying off staff and reducing rental costs during times of economic weakness. This makes the income profile for a landlord susceptible to the ebbs and flows of demand for space as dictated by the economic cycle.
On the other hand, the fundamental drivers of living assets – such as population growth and household formation – tend to be more stable. They are less dependent on short-term economic conditions (see Chart 5).
Chart 5: Volatility of real estate drivers, % per annum (1991 – 2018)Source: Aberdeen Standard Investments, October 2019.
As an order of magnitude, the underlying drivers of commercial real estate tend to be between five to ten times more volatile than the long-term drivers of living assets. This, of course, feeds into the income profile. Rents derived from commercial real estate tend to be two to three times more volatile than those from living assets (see Chart 6).
Chart 6: Real rent volatility, % per annum (2001 – 2018)Source: Aberdeen Standard Investments, October 2019.
Living assets have superior inflation-hedging characteristics compared to commercial real estate.
Evidence suggests that the rental income derived from commercial real estate can only hedge inflation in certain macroeconomic environments. Its effectiveness depends on whether the inflation is caused by demand or supply-side economic factors.
In the 1970s and 1980s, commercial real estate was an effective inflation hedge. This was demand-pull inflation generated by strong economic growth and rising oil prices across much of the developed world. However, this relationship broke down as weaker economic conditions became more pronounced in the 1990s.
On the other hand, US multi-family assets have recorded positive real rental growth over every rolling five-year period since the 1970s (see Chart 7). There is clearly a strong investment appeal attached to assets that can deliver real rental growth (and real net income) over almost four decades. Real rents are rents after inflation has been taken into account.
Chart 7: Five-year rolling ‘real’ US real estate returns, % per annumSource: Aberdeen Standard Investments, October 2019.
Unfortunately, residential rental data covering such a long period of time is not generally available for markets outside North America. That said, the same principle does apply to other jurisdictions.
This ability to protect investors from inflation in different economic conditions is expected to persist. The supply of living assets will continue to be constrained in most major cities.
What’s more, there is limited scope to increase residential housing supply. This is because of restrictive planning regulations, elevated land costs and constrained land availability. That is why real rents in the living sectors should be maintainable at the very least.
Low volatility, better risk-adjusted returns
Commercial real estate and living asset returns have tended to move in lockstep (see Chart 7). While comparable data for living sectors globally are not readily available, historical data in some jurisdictions have been encouraging. US living assets, represented in the chart by multi-family, have exhibited lower volatility over nearly four decades.
US commercial real estate assets were hit hard by the biggest financial shocks of the last two decades, such as the bursting of the dot.com bubble and the global financial crisis. However, US multi-family assets have delivered more stable performance and higher risk-adjusted returns over the same period.
The constraints on development, a growing propensity to rent over buy due to high prices, and regulatory impediments to mortgage lending, will continue to drive a structural demand-and-supply imbalance. These factors will exacerbate housing unaffordability and support investment into living assets, as well as risk-adjusted returns going forward.
Lower variability of rents and investment returns, compared to other real estate assets, will likely persist. The underlying drivers of population growth and household formation continue to be relatively stable and supportive in most major markets. These are appealing characteristics for investors.
Significant diversification benefits can be expected when adding living assets to broader real estate allocations and multi-asset portfolios.
For example, the US has the most established multi-family market in the world. Total returns for these assets have typically moved in tandem, although not in perfect alignment, with US commercial real estate.
Meanwhile, correlations with other more traditional asset classes, such as equities and fixed income, are weak. That’s why there are significant diversification benefits to be gained from adding a living asset allocation to multi-asset portfolios (see Chart 8).
Chart 8: US multi-asset total return correlation with apartments+1 = perfect positive correlation
0 = no correlation
-1 = perfect negative correlation
Source: Aberdeen Standard Investments, October 2019.
Living assets in other developed markets, such as Japan, exhibit similar diversifying characteristics. These markets respond to the same structural drivers of returns as living assets elsewhere, while the same supply-and-demand imbalance is also in play.
Declining interest rates around the world are making the returns from living assets look more compelling on a relative basis.
Lower interest rates will also mean lower funding costs during project development. This will make this asset class more attractive when investors evaluate the variation in borrowing costs associated with different real estate assets.
Stable and predictable cash flows in the form of inflation-linked rental income could form the foundation of an investment strategy for liability-aware investors.
Defined benefit pension schemes, in particular, can benefit from the predictable and reliable income stream from living assets. Schemes can match this income stream to their future liability profile.12
The income profile of living assets is similar to social infrastructure, for which returns are also driven by secure, inflation-linked cash flows. Rents are less volatile because they are less correlated to the business cycle than rental income from economic infrastructure assets or commercial real estate.
As an alternative source of contractual cash flows, investors using a liability-driven framework can include living assets. Living assets work well alongside existing fixed income investments to match future liabilities.
Therefore, living assets can also be a powerful way for liability-aware investors to diversify a portfolio. Capital values are less driven by interest rate volatility, as seen with fixed income investments.
Resilience to tech disruption
New technologies are changing traditional business models in many industries. Commercial real estate – retail, offices, industrial and logistics – are also affected.
The rise of e-commerce has reduced the need for bricks-and-mortar retail premises. This has benefitted the industrial and logistics sector as higher online demand requires reconfigured manufacturing and distribution processes. New processes require better designed modern buildings.
The effects on the office sector are more nuanced. New technology means workers have more flexibility as to where they work. This may reduce the amount of office space required if less common work practices, such as working from home, become more mainstream. That said, demand for high-quality urban offices remains robust over the long term.
On the other hand, living assets will be relatively unaffected. People will always need somewhere to live. Technology may alter the way people use the space within their homes. But technology won’t change the amount of space people need, or where they want to live.
Office workers who require flexible home working arrangements, will need to reassign space at home to do so. In fact, as people become wealthier they will likely want more room at home, not less.
Furthermore, the new technology adopted in homes tends to easily fit within existing building infrastructure. Technology does not render existing homes obsolete in contrast to some commercial buildings.
Bigger is better
Institutional investors often complain about the difficulty in deploying capital at the scale that they require.13
Bigger projects achieve economies of scale. A greater number of larger projects help investors deploy capital and achieve a more market efficient allocation.
In the UK especially, a lack of sizeable projects has hindered the pace of institutional capital flows. This has constrained the build out of this asset class.
One solution would be for investors to partner with governments to develop solutions. For a more detailed discussion, see ‘Digging Deeper – Private sector solutions to a global affordable housing shortage’.
Investors may also develop projects themselves, or provide equity financing, or forward-funding, for property developments to share the risk. Other investors may lend to developers to increase supply, especially in markets where there are inadequate funding options.
Evidence suggests that occupant demand for living assets has been much less variable. This is especially the case when compared to the demand for space in commercial real estate properties.
Private sector solutions
to a global affordable
Policymakers and private sector must learn to work together14
The shortage of affordable housing provision is a big problem for many of the world’s most successful cities. This not only affects existing residents, but also a city’s ability to attract the skilled workers needed to drive economic expansion.
This issue needs to be discussed by policymakers as well as those private sector companies involved in the financing and development of residential housing.
Insufficient affordable housing creates social problems. The less affluent are burdened by high housing costs, arduous commutes to metropolitan centres and inadequate space for living. These factors can destabilise communities and diminish economic productivity – issues that must matter to investors.
The growing prominence of sustainability principles, impact investing and gauging investment performance by metrics other than profit, all point to the role that socially-responsible investors can play in finding solutions.
But there are obvious tensions that need to be addressed. For example, policymakers have been turning to regulatory solutions based on various forms of ‘rent control’ or ‘rent stabilisation’.
Greater regulation is not necessarily a bad thing. The devil, as they say, is in the detail. There is room for more regulation as long as it is fair and stable.
For example, real estate investors have always supported the market for long indexed-linked income streams, which are controlled in all but name. These are common, at scale, across the US (in triple net lease structures where the tenant promises to pay all the expenses). They are also common in Europe (in long income strategies that establish long lease agreements with occupiers).
Rent control policies that are fair and consistent allow investors and policymakers to collaborate. This can form the basis of a collaboration that delivers affordable housing at the required scale.
Housing policies need to be stable and predictable to attract long-term capital. This will require a change in the way they are developed and implemented. That is not easy given that housing is a highly politicised issue.
Since 2000, the average tenure of each UK housing minister has been 14 months.15 That’s around half the typical occupancy period of the tenants in our UK portfolio. Policy instability, in whatever form, is not conducive to attracting capital at scale.
One solution would be to ensure that housing policy is set independently of short-term political interests, as with critical infrastructure. After all, in many jurisdictions, interest rates are set independently by a central bank that is free from government influence.
We think it is possible to work towards some sort of partnership between governments and the private sector to build affordable housing. It’s been done before in the financing of strategic infrastructure through public-private-partnership (PPP) agreements.
If partnership can form the central tenet of a new model of affordable housing, we see a workable solution. This is a model that balances the need for affordable housing with the considerable long-term capital that more risk-averse institutions want to deploy.
A basic model would see public land provided for free, or at low cost, on a leasehold basis. Private capital (perhaps with a public loan) would develop high-density, purpose-built housing. These properties could be operated independently by a specialist affordable-housing manager.
The separation of ownership and management would ensure fair treatment of residents. Meanwhile, investors would benefit from the clear and predictable income stream that these arrangements create.
Generating returns from housing will always be controversial. However, the need is clear. Our industry needs to engage in an open and robust discussion about viable long-term solutions. We welcome all contributions to this debate.
Delivering value through design
and active management
Happy Tenants = Happy Landlords
Maintaining a constructive relationship with tenants is simply good business practice. By treating tenants fairly, they are likely to stay longer. There is a clear benefit to income by improving tenant retention and reducing unnecessary void (vacancy) rates, which are detrimental to performance.
Having the right unit design, in well considered buildings that residents want to live in and can afford, is good business.
Landlords should not push for onerous lease clauses, but instead offer terms that work for tenants. Life circumstances change and tenants want the flexibility of short- and long-stay options. Tenants also value a simple, fair and transparent pricing structure.
Limiting the costs – fees, repairs, voids – associated with changing tenancies produces savings that are good for long-term returns. Our own experience of managing living assets in Europe supports this observation (see Chart 9).
Chart 9: Illustrative five-year net income for three tenant turnover scenarios*Five years cumulative rental income, indexed from 100 in Year 1
Source: Aberdeen Standard Investments, February 2019.
Within the Aberdeen Standard Investments residential real estate portfolio, tenants in Germany tend to stay for around a decade. This translates into a 10% turnover of occupants in a building each year. Our tenants in the UK, however, only stay for some 2.5 years, which equates to a turnover rate of some 40%.
The net effect of this is significant. With all else being constant, a UK landlord would have to see market rental growth of around 4.8% to deliver the same return as that delivered by a property in Germany, where rents are connected to inflation-linked increases (assumed to be 1.5% a year).
Investors need to focus upon the right buildings, appropriately designed and in the right locations. For example, the central tenet of our own asset selection process is our ‘Triple A’ principle. Assets must be:
- affordable to workers on average salaries
- close to plenty of good amenities
- accessible within the local economy
Investors must recognise that living assets are a long-term investment and buildings should be managed with the long-term satisfaction of tenants in mind.
Having the right unit design, in well considered buildings that residents want to live in and can afford, is good business. A relationship with tenants that is more harmonious than adversarial makes business sense.
Our paper ‘Happy Tenants = Happy Landlords’ argued that driving management efficiencies is at least as important as pursuing rental growth, when investing in living assets.16
Dispelling the myths of management challenges
Some institutional investors used to take a dim view of the living sectors. They may have considered the income profile from living assets to be more uncertain, due to the shorter leases and the tendency for tenants to be more financially vulnerable. Some would have been put off by the fact that, unlike commercial real estate, living assets are not let on full repairing-and-insuring (FRI) terms.
The need for direct management to secure the desired income profile makes investing in the asset class daunting for many investors.
However, our experience as one of the largest landlords of living assets in Europe has typically been favourable. What’s more, institutional investor attitudes towards living assets are changing, according to the Investment Property Forum (IPF)17.
An annual IPF survey has monitored investor sentiment towards UK residential real estate over the years. It shows that resistance to the living sectors is waning (see Chart 10).
Chart 10: Common barriers to investing in UK residentialSource: IPF, 2019.
Reasons given for not investing during the early years of the survey – management complexity, difficulties in achieving scale, reputational risk, illiquidity – are cited less often these days as obstacles to investment.
In fact, another industry survey suggests that many investors in European living assets planned to increase their allocations to this asset class in 2020.
More than half (53%) of the 70 investors surveyed are looking to increase allocations, according to the JLL / Aberdeen Standard Investments poll.18 Only 9% said they planned to reduce or eliminate their exposure. The survey canvassed investors representing some €6 trillion in assets under management.
Of course, there can be challenges when dealing with tenants’ idiosyncrasies. But the underlying real estate is relatively standardised and the management requirements transparent and predictable.
Investing in living assets is increasingly borderless. There are professional management practices using global best-in-class techniques, such as standardised management models that can be redeployed for different markets.
This has drastically lowered the barriers to entry associated with the operation of these assets. In fact, there are few markets where we have operational concerns. The operational information that we do have is usually very good and getting better.
The information we have about our tenants’ habits and lifestyles is, in many ways, superior to what we have for commercial real estate properties. For example, there are distinct variations in the performance of apartments of different sizes. Smaller dwellings in our German assets are leased out more swiftly and achieve the highest rent per square metre. Larger apartments, perhaps more suited to families, lease more slowly and at a lower rent on a per-square-metre basis. This seems to suggest a clear strategy for asset selection and design.
However, it is also important to know that people who rent smaller apartments usually stay for shorter durations. Operational efficiency is therefore challenged by the higher costs associated with greater tenant turnover. Investors need to consider these factors in each investment made.
Investors may benefit from influencing asset design during the early stages of development. These days, many investors seek to develop investable assets themselves or forward-fund agreements to provide equity for asset development.
In one example, we were able to acquire several private rented sector apartment blocks in Dortmund, Germany (see Chart 11). The assets had been developed to a ‘shell-only‘ status, but designed with two apartments on each floor. By adding a smaller third apartment on each floor during the fit out stage, we increased costs by around 5%, but rent-yielding space rose by some 20%.
Chart 11: Efficient design can increase rents per square metre at little additional cost
Before: €2,045 ERV/month
3 room apartment ~90m², €945 Market rent
4 room apartment ~115m², €1,100 Market rent
After: €2,490 ERV/month
3 room apartment ~82m², €945 Market rent
3 room apartment ~81m², €945 Market rent
2 room apartment ~49m², €600 Market rent
Responsible investment benefits tenants and investors
Researchers have yet to establish a definitive link between good environmental, social and governance (ESG) practices and better investment performance for living assets. But investors should appreciate the benefits – financial and otherwise – of integrating sustainability principles into the design, selection and management of properties.
When landlords provide homes with lower utility costs through better energy efficiency, this should lead to greater tenant affordability and increased tenant retention. Longer tenancies can create a sense of community that has wider benefits for society. For investors, occupants who stay longer deliver a more stable income and higher returns.
Investors may benefit from cheaper borrowing costs. For example, we managed to secure lower financing costs when we acquired a residential property in Copenhagen, Denmark. The building’s high energy efficiency rating of A (one of the highest possible) meant that financing came in at 10 basis points lower than borrowing costs for a building not rated for energy efficiency.
Living assets will become an important component of modern approaches to true impact investing. The delivery and ongoing management of these assets are critical to the success of our communities. This, in turn, will be good for local economies in ways that are measured beyond standard investment metrics.
That’s why we own residential buildings that deliver: carbon, energy and resource efficiency (e.g. charging stations for electric cars, centralised heating systems, solar panels, underground heating solutions, rainwater harvesting); tenant wellbeing (e.g. buildings designed with shared central spaces, communal gardens); and accessibility (e.g. buildings located to shorten commutes and improve access to services).
The rise of rent regulations
‘Winning cities’, the world's most successful magnets of capital and migration, are growing rapidly but struggle to provide suitable affordable housing for inhabitants.19
With the pace of new housing development lagging demand, property prices and residential rents have risen to levels that people on average salaries struggle to afford. This is causing major problems for policymakers as they try to prevent cities from becoming places where only the rich can live.
It raises the issue of socio-economic efficiency. Politicians around the world are now discussing various ways to tackle this challenge and ideas include subsidised rents and housing, or rent control. Berlin’s bold decision to introduce a rental cap and freeze in central areas has caused uncertainty for investors.20 But policymakers elsewhere are considering similar measures.21
From an investor’s perspective, greater tenant protection in residential leases is not necessarily bad for investment performance. This is particularly the case for income-focused strategies. More predictable future housing costs and controlled rental growth are likely to lead to a lower turnover of tenants. This will have associated benefits for landlords.
Our analysis of MSCI data shows that historical annualised returns for European markets with rent regulations have not systematically underperformed those markets with no controls in place (see Chart 12). However, increasing political uncertainty and potential changes to legislation may increase volatility for the asset class. This may have negative short-term effects on capital values.
Chart 12: Annualised residential asset total returns since domestic MSCI inception, %
Rent ControlPartly RegulatedFree Market RentNote: Year of inception in brackets
Source: MSCI, September 2019.
Whether rent regulation can fix the affordable housing issue is a complex question. In order for this to work, regulation needs to be fair and consistent. If it isn’t, it will discourage investors and developers from deploying capital into the sector. The fundamental problem of insufficient supply will just get worse.
Rent regulation needs to be combined with measures that stimulate the supply of more affordable housing in order to overcome the underlying problem. We urge investors, policymakers and governments to open up the debate and to collaborate. It is the only way we will start to develop sustainable solutions.
Having the right unit design, in well considered buildings that residents want to live in and can afford, is good business.
In cities around the world, the average person cannot afford to buy an average home. The huge global demand for housing has made ‘living assets’ the real estate investment theme of our time. But there are challenges in achieving the potential reward for investors.
Some countries have extremely well established living asset markets, yet others are still nascent. Historical data is incomplete for many countries. But where the data is available, income return has been appealing, volatility limited, and total returns compelling on an absolute and risk-adjusted basis. The fundamental drivers of these returns are expected to persist for some time.
Direct management of living assets may put off some investors because of the operational risks involved. But best-in-class operational techniques are spreading fast, even to nascent markets where direct management of living assets is uncommon. Once these techniques are more established, capital will follow.
There is greater opportunity in mainstream and affordable housing. Our asset selection is based on the ‘Triple A’ principle – seeking locations and buildings that are accessible, affordable, and near established amenities.
Management information derived from professionally managed properties can exceed that typically gleaned from commercial real estate. The amount of information can only grow as this asset class expands. This will help investors decide the best asset mix to meet the needs of the community, while maximising income and minimising risks. Ultimately, housing assets need to be places that tenants want to live in.
Living assets are more resilient than other real estate assets against the risk of technological disruption. While technology may improve information flows, it does not fundamentally alter our need for a home.
The shortage of suitable living assets is a well-documented social problem. It is also an impediment to institutional flows since there are limited investment opportunities. The problem has attracted the attention of policymakers and this, in turn, has created risks. But it also creates opportunities.
The highly politicised environment surrounding housing provision is some way from being settled. New regulation, however well intentioned, could undermine the considerable opportunity to attract private capital. Investment from the private sector will necessarily form part of any solution to provide sufficient affordable housing. This is not to challenge political intention. Investors and policymakers need to work together to achieve a common goal.
1United Nations (2018) 68% of the world population projected to live in urban areas by 2050, says UN. https://www.un.org/development/desa/en/news/population/2018-revision-of-world-urbanization-prospects.html [Accessed 16th September 2019].
2Sakes, R. E., (2008) Job creation and housing construction: constraints on metropolitan area employment growth, Journal of Urban Economics. 64, 178-195.
3Jones Lang LaSalle, Aberdeen Standard Investments, (2019) European Living: What’s the investor appetite? London, United Kingdom.
4Morrison, D., Phillips, M. (2019) Emerging Trends in Real Estate: The global outlook for 2019. https://www.pwc.com/gx/en/industries/financial-services/assets/pwc-etre-global-outlook-2019.pdf [Accessed 17th September 2019].
5Geng, N. (2018) Fundamental Drivers of House Prices in Advanced Economies, International Monetary Fund. https://www.imf.org/~/media/Files/Publications/WP/2018/wp18164.ashx [Accessed 18th September 2019]
6Glaeser, E.L., J. Gyourko, and A. Saiz, (2008) Housing supply and housing bubbles, Journal of Urban Economics. 64 (2), 198-217.
7Gyourko, J., C. Mayer and T. Sinai, 2013, Superstar Cities, American Economic Journal: Economic Policy 5 (4), 167-199.
8Aberdeen Standard Investments, (2018) Improving property portfolio performance through diversification.
9Aberdeen Standard Investments (2019) Happy Tenants = Happy Landlords.
10Aberdeen Standard Investments, (2018) Homing in on residential property for your portfolio.
11IPE Real Assets, (2014) The inflation matching characteristics of mixed tenure private housing. https://realassets.ipe.com/download?ac=51555 [Accessed 20th September 2019].
12Investment Property Forum, (2015) What constitutes property for investment purposes? A review of alternative real estate assets. http://www.ipf.org.uk/asset/0EE7335D-F8CB-41AC-B12CEB8CE1670EA5/ [Accessed 20th September 2019].
13Investment Property Forum (2019) UK Residential Property: Institutional attitudes and investment survey.
14Aberdeen Standard Investments (2019) European affordable housing challenges: The risks and rewards of rental regulation.
15Construction Products Association (2019) How many housing ministers in 20 years? https://www.constructionproducts.org.uk/news-media-events/blog/2017/september/how-many-housing-ministers-in-20-years/ [Accessed 27th November 2019]
16Aberdeen Standard Investments (2019) Residential Real Estate: Happy Tenants = Happy Landlords.
17Investment Property Forum (2019) UK Residential Property: Institutional attitudes and investment survey.
18JLL/Aberdeen Standard Investments (2020) European Living Investor Survey
19Aberdeen Standard Investments (2019) European affordable housing challenges: The risks and rewards of rental regulation. For a detailed discussion of ‘winning cities’ please refer to our paper, (2018) How to invest in real estate in global winning cities.
20Financial Times (2019) Berlin approves drastic measures to curb surging housing costs. https://www.ft.com/content/0fa537b6-f4cd-11e9-b018-3ef8794b17c6 [Accessed 31st January 2020]
21London Assembly, (2019) Mayor demands powers to bring rents down. https://www.london.gov.uk/press-releases/mayoral/mayor-demands-powers-to-bring-rents-down [Accessed 31st January 2020]