Iryna Pylypchuk. director of research and market information at Inrev, analyses what is needed to tackle the twin challenges of affordable housing and decarbonisation.
The residential sector embodies two of the greatest challenges for reaching a just transition of economy and society – namely, the provision of appropriate and affordable housing against unmet demand, and the decarbonisation of Europe’s housing stock on the path to net zero.
Given the persistent structural shortage of Europe’s housing over the next decade, the demand for the sector is expected to grow even further, according to Inrev’s latest report, Unlocking affordable PRS to address twin challenges.
In the Inrev/Anrev/Prea 2024 Investment Intentions Survey, 90% of investors indicated that residential was their preferred investment sector in Europe, with the Inrev Quarterly Fund Index highlighting particularly high allocations to the Private Rented Sector (PRS) across the Netherlands, UK, and Germany.
Attracted by stable long-term income returns, the growth of investment in the sector represents a unique opportunity to meet financial objectives while tackling sustainable development goals that cut across both climate change and wealth disparity. But significant obstacles remain.
Enforcing affordability
Determining and achieving ‘affordable rent’ is vital for investment in PRS, both for realising risk-adjusted returns, as well as addressing Europe’s housing crisis through the delivery of long-term tenure at a sustainable rent.
However, currently there is no agreed definition of what constitutes rental affordability, and, in many locations competing market opportunity to provide tenure for higher income households presents a significant obstacle.
These issues, alongside competing land uses or limitations on density, have led to the suggestion that investment in PRS may become dependent on subsidies to level the playing field. These include a range of suggested measures such as tax breaks, public land availability, accelerated planning, access to debt at a lower cost of capital, or public grants and public co-investment.
In fact, according to a residential survey conducted by Inrev in May, some form of direct or indirect subsidy was considered important by 94% of respondents, while over 25% believe such intervention to be essential to the viability of intermediary PRS.
Delayed decarbonisation
Creating affordability across Europe’s rental sector can have a direct relationship with decarbonisation, while decarbonisation strategies may also facilitate the viability of intermediary PRS if such capital expenditure is considered as an investment, rather than as a mere cost.
By improving energy efficiency, overall rental affordability is improved, leading to greater certainty of net income and reduced non-payment, void, and churn rates. As a result, both decarbonisation and affordability are considered to be significant drivers of performance. For example, over half (57%) of respondents from the residential survey agree that decarbonisation maximises returns over the long-term.
Although most institutional investors and managers consider fiduciary duty and decarbonisation to be fully aligned, there are clear challenges facing implementation. In particular, as market pricing adjusts to higher interest rates, investors and managers are seeking to protect value. The 2024 Investment Intentions Survey revealed that many investors are now delaying decarbonisation strategies due to the ongoing challenging market conditions.
On top of this, there is also acceptance that current valuations do not fully reflect decarbonisation risks, meaning the value of low carbon assets may be understated, or high carbon assets overstated. As a result, it is more difficult to justify the initial high cost associated with decarbonisation strategies.
Due to this, in the absence of regulation or more punitive carbon pricing and a forward-looking valuation process, investors and managers must continue to balance both short and long-term fiduciary duties.
In the short-term, a suggested partial solution may be to stagger investment annually and undertake lower cost works that have a high carbon reduction impact such as retrofitting initiatives, including loft and wall insulation, or repointing windows. Over half (57%) of respondents also agree that some form of assistance is required to support the costs of decarbonisation associated with affordable housing investment.
It is clear that institutional investors and managers are eager to invest with a purpose where it aligns with their financial objectives and fiduciary duty to meet the needs of underlying pensioners and savers. And PRS offers a clear opportunity to generate long-term secure income streams, while positively contributing to sustainable development goals.
However, where there are competing higher use values, intermediary PRS requires some form of direct or indirect subsidy to assist if it is to be considered a viable investment opportunity. Here, public policy initiatives can make a huge difference.
Governments and policymakers keen to access institutional capital to help them address Europe’s housing and climate crises should consider developing initiatives that facilitate such investment. Ideally, this should be a component of wider housing policy that seeks to address imbalances across the housing spectrum and strategically directs institutional capital to the most appropriate segments.
Such policies should also embed sustainability objectives, especially decarbonisation. The opportunity to address the twin challenges of housing need and climate change in unison should not be wasted.
