If you type “affordable housing” into Google, there are more than 1.5 million results within 0.6 seconds. That is the definition of a hot topic. Europe is facing a changing economic environment, interest rate hikes and high inflation. This is putting additional pressure on disposable incomes. A roof over our heads is one thing – being able to truly afford it is another.

Defining ‘affordable’

But what do we mean by affordable housing? There is no absolute definition, and it varies between countries, cities, governments and housing associations. Unfortunately, affordable housing tends to refer to second-hand properties that are less efficient, often in secondary locations and occupied on a rental basis. They can be privately owned or let by not-for-profit government organisations or other licensed authorities. Importantly, they usually involve some kind of rent subsidy or benefit package that enables tenants to afford the rent.

At abrdn, we classify a rent as affordable if it doesn’t exceed 30-40% of the disposable household income at the start of the lease, depending on the country or city in question. An additional measure, which can help bring out local sensitivities to rental costs, would be to compare the typical mortgage costs with the equivalent rent for the same quality of apartment.

Quality as part of affordability

Affordability is not just about the rent. A key complexity with understanding affordability is wrapped up in how much it costs to run an apartment, too. This is known as the overall expense ratio. Quality also includes how much a household must spend on the property, such as energy costs, maintenance and other bills. Europeans are now paying an average of 30% more on energy bills since the start of 2022, while inflation overall has been running into double digits in many countries. Other measures of quality include location and amenities, both of which can influence daily costs for tenants needing to travel further to work or to school.

Efficiency is an increasingly important factor, given the substantial increase in the base cost for most tenants. It is rapidly becoming a double-edged sword for tenants in poorer-quality properties. Not only are they losing out due to the increasing burden of daily living costs, but their rental budget is being squeezed, too. It feels like an unsustainable situation for many.

We classify a rent as affordable if it doesn’t exceed 30-40% of the disposable household income at the start of the lease

Rent regulations

Given the affordability crunch that households find themselves in today, we expect to see more regulations put in place. Increasing rental regulation has been happening for some time across Europe but with local differences.

New-build residential leases are typically inflation-linked in Europe – a common practice that was introduced in Denmark, Spain, France, Germany and the Netherlands. This acts to ensure that rents move fairly and in line with other expenses. In theory, rents should track long-term income growth. This has worked well on the whole as real wages have been increasing in recent years and the affordability of existing tenancies has not worsened – until recently. The spike in inflation and fuel costs has broken down this relationship, which is why we have seen increased short-term measures to protect households. Nominal wages in the Eurozone increased by 3.9% over the year to the third quarter of 2022, but actually fell by 5.8% in real terms – the largest annual fall in real terms since the inception of the Eurozone. With high inflation sticking around for longer, the situation is unlikely to improve.

Demand versus supply

We believe that providing new and efficient affordable accommodation will be one of the major topics of concern this year. The lack of affordable housing in Europe is significant and varies depending on the country and region. In 2020, approximately 10.5% of Eurozone households had reduced rents, while an additional 23.9% were renting at open-market levels. We expect the share of those requiring reduced rents will increase, partly because of Europe’s 60 million mortgaged households that are being squeezed out through higher interest rates and lower household incomes.

With higher costs for land, building materials and labour, the delivery of new affordable housing is increasingly difficult. High energy costs and rising labour costs are leading to elevated construction costs, which are negatively affecting household budgets. This means that high costs are squeezing the affordability of rents even further. While inflation is showing signs of cooling, the economy is unlikely to enter a disinflationary environment in the foreseeable future, meaning costs are likely to remain high.

The investment gap

The Organisation for Economic Cooperation and Development estimates that there is an investment gap in the provision of affordable and social housing of €57 billion per year in the EU. Until housebuilding can reach the necessary levels to ease housing pressures, affordability in the rental market will remain under pressure. In Germany, the research consultancy Pestel estimates that there is a current shortage of 700,000 homes. It would take another three years to provide this at the current rate of development, excluding any additional housing requirements during that period.

One way to make rents more affordable is to build new stock at the right quality and efficiency in the right locations. However, the private sector cannot do this alone. Such has been the increase in cost of land and construction, it is no longer economically feasible to deliver housing at affordable rents. If land subsidies or public funding to support private investment is needed to achieve lower rents, then that needs to be considered by the government departments responsible for housing policy. Until new creative ways are found to deliver enough efficient housing to tilt the demand and supply imbalance back towards tenants, the affordability conundrum will remain unanswered.