As European investors rush into the residential sector to get their share of opportunities, experts ask what risks lie dormant.
While multifamily has been an institutional asset class for decades in the US, the recent emergence of significant demand in Europe for residential marks quite a shake-up for commercial real estate.
Research from Green Street finds that most of the Continent’s institutional property investors indeed now consider themselves underweight on residential and overweight on the traditional commercial sectors - even offices. But with pan-European pricing on beds at an all-time high – up around 50% compared to 2007 – and inexperience rife even amongst the largest funds, should investors rather be asking what risks lie dormant?
‘The biggest risk is “stroke of the pen” risk,’ suggests Peter Papadakos, head of European research at Green Street, and author of a new, major analysis of Europe’s residential markets. ‘You wake up one day and the government has decided to regulate rents. All other risks are connected to investors paying for future growth which never materialises. But that’s a classic risk that appears in all sectors.’ Papadakos explains: ‘You could encounter weakened demand, due to affordability aspects or tepid household formation growth; aspects of a pandemic-induced recession. But rent control is the biggest risk, and the most likely.’
It’s a key concern, considering the price pressure on the sector at the moment and its significantly low yields. These aspects have also compelled many investors to pursue a development route, in the hope of broadening margins. But the recent lessons of Berlin loom large. While a five-year residential rent cap instigated in the German capital in 2020 – that spooked even the largest and most savvy German landlords – may yet be deemed unconstitutional, most investors don’t want to do battle with such a politically charged issue as housing.
Niche beds
One investor strategy has been to explore residential’s sub-sectors, from co-living to senior care. Yet Papadakos suggests the niche sectors present a more sinuous route to success, not least because they require different types of expertise and often represent even lesser explored territory. ‘Co-living is so small it lacks sufficient data across markets to really have a view. But anecdotally, we saw occupancy rates collapse, and market rents drop quite a bit,’ he notes.
Quarters, the co-living brand of Berlin-based Medici Living, saw its dreams of US expansion crumble during the pandemic when it ended up declaring bankruptcy across all 10 of its US properties. This despite raising $300 mln to launch beyond the Atlantic in 2019, in the wake of amassing $1.4 bn of backing for its European operations. Marketed (perhaps unhappily) as the ‘WeWork of co-living’, Quarters’ model of subletting long-leased premises may have exposed it to the same risks as its flex-office counterpart.
But other co-living ventures have declared themselves rather more ‘pandemic-proof’, such as the tie-up between DTZ Investors and The Collective, Coliv, dubbed ‘the world’s first institutional co-living vehicle’. DTZ Investors recently forward funded the development of a 260+ room scheme in Battersea, its third such venture after The Collective Harrow and The Collective Earlsfield. The Collective Battersea will provide 35% affordable housing, available at a discount market rent for people with starting salaries of £22,000 p.a.
Says Christian Birrell, investment manager of Coliv: ‘I don’t think co-living has had a rough time at all. It’s a very compelling proposition in a city like London where many workers can’t afford a one-bed flat. We saw a ramp-up in occupancy from summer onwards last year after an initial dip caused by the pandemic.’
He adds: ‘We are backed by long-term, patient capital, and our JV with The Collective means that they are finding the sites to design, build and operate the assets. Also, our co-living model is essentially BtR with a greater focus on amenities and community building. The benefit is we can be 20% cheaper because the space in buildings is used more efficiently – it’s a similar concept to micro-living.’
Ultimately, Coliv aims to raise total equity commitments of up to £650 mln and to amass between six and 10 co-living assets in London, with a target gross value of £1 bn. To date, investors including the Merseyside Pension fund and the Strathclyde Pension Fund have jumped on board.
The specialist approach is working for other investment types as well, notes Papadakos. ‘In senior housing, skilled nursing has held up well, especially in Continental Europe. In Germany, for example, there wasn’t much change in occupancy. The situation was more negative in the UK and Spain.’
He adds: ‘Student housing has been worse than senior housing but not as bad as co-living – we’re looking at 20% declines in organic rental growth. But I think that will be back to normal from September 2021, whereas co-living might take a little longer, due to rents softening generally and tenants having a wider range of options in cities.’
BTR opportunities
Ultimately, traditional multifamily is still attracting the lion’s share of the attention across the living category. Whilst total commercial real estate transaction volumes declined by double digits in 2020 across Europe, residential sector deals increased in the high single-digit percentage range, Green Street data shows. ‘Multifamily is the most robust in terms of rent collection and stable occupancy,’ Papadakos notes. ‘It also offers real rental growth.’ While shelter-in-place directives during the pandemic helped crystallise its investment case, BTR’s fundamentals look good in the medium to long term.
The roll-call of names now active in the sector backs this thesis. Barings, which recently announced it is targeting some €2 bn of European equity deals in 2021, hopes that up to half a billion of that will be in residential. Gunther Deutsch, head of real estate transactions – Europe at Barings, says the firm will focus on ‘BTR, then student housing, and potentially micro-living/serviced’, after the firm recently acquired its first two student properties in the UK. ‘Student housing is growing long term,’ he says. ‘It obviously depends on what capital we are working with, but for core strategies where we are holding for 10 years, we can easily ride out any kinds of short-term market disruption.’
Deutsch also thinks that targeting development opportunities across the sector will continue to give Barings an edge. ‘Developers can’t get bank finance as easily as in the past – that’s where we come in. We want to develop relationships for building multiple schemes, not single deals.’ Despite the weight of capital looking to move into beds, Deutsch is optimistic. ‘We are trying to find value across Europe, but it still presents a lot of opportunities. We don’t think there’s a bubble or that it’s getting too hot: there’s simply so much to do.’
The social choice
If rent control is a risk factor in residential investment, the ‘beat ‘em, join ‘em’ solution is to partner with local authorities on the provision of affordable homes. Often distinguished by significant rent caps, governments in turn guarantee some, if not all, of the rent or provide low-rate loans to tenants, many of whom ‘queue’ for years to access social housing.
Savills reports that affordable and social housing accounted for nearly 40% of total German residential transaction volumes in January 2021. Allianz Real Estate was one of the firms joining the sector, as it made its social housing debut in Nuremberg in the state of Bavaria, with a 300-unit affordable housing deal. The portfolio’s three assets, due for completion by the end of 2022, aid Allianz’s carbon neutrality ambitions, with their development aligning with the carbon risk real estate monitor (CRREM) decarbonisation pathway. Says Annette Kröger, CEO region north & central Europe at Allianz RE: ‘The Schultheiß portfolio is an excellent opportunity to gain traction in affordable housing where we see potential to scale up.
‘At the same time, and as one of the world’s largest investors in real estate, we have a responsibility to grow our portfolio through assets that have a positive environmental impact, which is why we will invest further into these properties so that the future tenants are housed in industry leading homes.’
Indeed, the ESG aspect is also a compelling case for affordable housing. Green Street research finds that for example, in the UK, public social housing companies are often ascribed larger premiums to their underlying asset value relative to less regulated institutional landlords. While there are underlying risks – which include break points in individual tenancies despite operators usually signing very long leases – the potential for social housing to fulfil ESG allocations is an increasingly powerful one.
PGIM Real Estate recently launched its UK affordable housing fund with an initial capital raise totalling £190 mln from the Northern LGPS and Brunel Pension Partnership. Meanwhile, new UK propco Home REIT raised £240 mln from its IPO late last year with an investment case to house the homeless in partnership with local authorities and registered charities. Home’s assets are diversified across various sub-sectors including women fleeing domestic violence, people leaving prison, individuals suffering from mental health or drug and alcohol issues and foster care leavers, showing the increasing granularity of this burgeoning sub-sector.
