Affordable housing Europe: Should investors be part of the solution?

This year, the Netherlands introduced new housing regulations. The legislation allows individual municipalities to ban property developers from investing in certain lower and middle-income neighbourhoods and then renting those assets out. 

While each municipality is considering its position with respect to the ban, nobody disputes the need for it. Of the homes sold in Amsterdam, The Hague, Utrecht and Rotterdam in 2020, 34% were sold to people who were not intending to live there themselves, according to broadcaster BNNVARA. There are roughly eight million homes in the Netherlands, and almost 700,000 are in the hands of private investors. 

Meanwhile, social and affordable housing is deeply undersupplied. Public broadcaster NOS estimates that in Amsterdam applicants are registered for social housing for an average of 13 years and 10 months before a place is found.

Similar statistics are mirrored across Europe. In Stockholm, it can take an average of nine years to be placed in a rent-controlled property, while in England waiting lists for social housing have been above one million households since 1997, according to an October 2021 report commissioned by the Impact Investing Institute, alongside Property Funds Research, Homes England and the Investment Property Forum.

It is unsurprising, then, to see governments and municipalities across the region try to address the problem. In Germany, the Mietspiegel rent regulation system determines rent, while in Paris, there are regulations on maximum rents in certain areas. In Ireland, ‘rent pressure zones’ have been in place since 2016. Spain’s new housing bill, due to take effect in the second half of 2022, will limit rent charges and impose taxes on those who leave properties empty.

“Creating affordable living for citizens has been a key driver from municipalities… as demand continues to outstrip supply and put pressure on housing across the board,” says Stuart Osborn, head of European residential investment transactions at Knight Frank. “As a lot of the residential now being developed is institutional quality, with rents to go along with it, governments want to protect the provision of affordability.”

For institutional investors, therefore, affordable housing presents both challenges and opportunities. Investors see the benefits that affordable housing can bring to a portfolio. They are also keen to do the right thing.

Tom Colthorpe, associate, EMEA living research and strategy, at JLL, says. “The reason why affordable market housing has got a lot of attention in the last two years is because ESG has become the number one priority for real estate investors when it comes to rebalancing portfolios.”

However, investors are also mindful that there are significant operational hurdles to get to grips with. “Affordable housing is an incredibly attractive investment proposition,” says Martin Zdravkov, lead portfolio manager at DWS. “Rents are set below the market, which has a more-than-average consumption pool, which should translate into lower turnover and lower voids. So from a macro perspective, investors absolutely love it. The challenge is on the operational side. Creating the product and accessing it is a challenge.”

Investors who can address operational issues can benefit from the sector’s cash-flow characteristics and low correlation to the wider economy, which bring diversification benefits. In the UK, the social-rented sector has seen low and stable vacancy levels with less than 1.5% of stock vacant over the past five years, according to the Impact Investing Institute report. The report also highlights affordable housing’s positive relationship with changes in inflation, with annual rent reviews typically linked with inflation indexes.

“If you look at affordable housing in the last two years through COVID, in the first six or 12 months, the operational performance of mid-market residential was even better than the premium-end product in terms of occupancy and rent collection,” says Colthorpe.

In the UK, where affordable housing is still very much in its infancy, private finance plays a significant role in the market. Currently, about 70% of capital raised by private-registered providers to invest in social and affordable housing is from private (currently predominately debt) financing sources, up from 30-40% in the 2000s, according to the Impact Investing Institute report. However, equity investments are growing.

Several initiatives took place last year. Gresham House Residential Secure Income announced a partnership with residential developer Charles Church to deliver 61 shared-ownership homes in Solihull, while Man Group Private Markets announced an investment in a residential development at Coombe Farm, Saltdean; and Aviva Investors partnered with Packaged Living, the specialist UK build-to-rent developer, to create a single-family rental platform for suburban homes in the country. At the beginning of 2022, CBRE Investment Management’s affordable housing fund and Thrive Homes bought a portfolio of affordable-rent and shared-ownership properties as part of a long-term partnership.

Shamez Alibhai, head of community housing and portfolio manager at Man GPM, says the firm is taking a holistic view of its involvement in the space. “We have taken the view that we, and our investors, would like to use this capital to solve real problems in the housing market and not just look at the asset class,” he says.

Alibhai believes that investors should be wary of rent-seeking behaviour in the industry, arguing that social rental yields have grown faster than private-market yields, in part because their rent levels are set by government rules on a consumer price index-plus basis, allowing them to outperform relative to inflation. However, investing in areas where rent inflation exceeds market rent inflation can be a problem, he says.

“Investors need to think about the ecosystem as a whole. If you are a private investor and you are invested in part of the country where rents are flat, and you are increasing rents at CPI-plus-one because that’s what the government policy is, then that can be seen as rent-seeking behaviour, and that’s what I’m worried about.”

Alibhai also points out that environmental and social synergies are key. Man GPM’s Saltdean development will combine fabric improvements with air-source heat pumps and photo-voltaics, expecting to reduce the carbon emissions of the homes by at least 46% lower than that required by UK building regulations.

“The environmental and social are linked, so from a people perspective, it reduces the housing costs for a family,” he says. “It’s not just rent or mortgage, it’s also energy and utilities. If we can bring down their housing costs, that makes their lived experiences better, and that’s important.”

Other fund managers also stress their focus on climate credentials, pointing out that any housing will have to stand the test of time. Ben Fry, head of housing investment at Gresham House, says: “Sustainability is a massive focus for us. We have a customer charter to set out how we want to deliver best-in-class service. We are delivering a scheme in Essex at the moment that’s delivering over 100 net operationally carbon-free homes, so it’s got solar panels and air-source heat pumps to generate peoples’ electricity and heating requirements. We are looking to introduce this type of thing as much as possible as part of our move to net zero.”

Market access
In addition to sustainability, investors will also have to think about how they access the market, whether they take a broader approach, or invest in a sub-sector of the asset class – for example, shared-ownership schemes, social-rent homes, or affordable rent. 

Catriona Buckley, institutional business development director at Gresham House, says: “Within affordable housing there are very different sub asset classes, and they each offer different things. Shared ownership is very different to build to rent, which is different to social housing.” 

Managers are positioned in different ways. Angus Henderson, head of business development at BMO Real Estate Partners, says: “We are at the more affordable end. We see that as the deepest and broadest market, and we believe it is a market that is poorly served.”

In August last year, the BMO UK House Fund acquired the Hughes House scheme in Liverpool city centre through a £40m (€48m) forward-funding agreement. The fund’s stated aim is to deliver high quality, sustainable, community-based rental property for low to middle-income households whose needs are not currently being met by the existing private-rented sector.

“If you look at the number and quality of existing assets, it is very fragmented and not institutionally governed. We have barely scratched the surface in terms of what needs to be delivered,” says Henderson.

Scale is a key issue, agrees Douglas Crawshaw, global head of real estate at investment consultancy WTW. “It’s difficult to invest in good quality existing stock,” he says. “In the UK, the vast majority of residential investment is in private hands – mom-and-pop investments which make it difficult for an institutional investor to invest in large quantities of capital. You get around it by building, but you also aren’t getting any income unless you are forward-funding a development for your authority where you might get a development yield. The time it takes to become income-producing can put people off.”

Research from the Urban Land Institute (ULI) recommends that European cities build more homes tailored to the ‘squeezed middle’ of home buyers and renters – those not eligible for social housing but cannot afford market prices or rents. ULI argues that cities should work with the private sector to develop new collaborative funding models to better share risk and rewards. Lisette van Doorn, CEO of ULI Europe, says: “There needs to be a collaborative approach on the public and private side, and maximising land value is an important part of that.” 

The middle segment is a good opportunity, says Paul Oremus, fund manager for the European Residential Impact Fund and Dutch Residential Fund at CBRE Investment Management. “In almost every large city in Europe you can see it’s the mid-price segment where the market is big but the supply is low,” he says. “Almost one third of households are looking in that price category, so in our view it’s a big opportunity for the affordable housing segment.”

Whatever sub-sectors they allocate to, successful managers also need to take a long-term approach.

PGIM Real Estate made the first acquisition for its UK Affordable Housing strategy – a portfolio of eight single-family for-rent residential housing sites – in June last year. Charles Crowe, head of UK transactions, says: “We see a split between fund managers who are long-term strategic managers, versus asset accumulators looking to sell.

“Our view is that affordable housing is an evergreen situation. We firmly feel that the sector offers good long-term income and sustainable revenue streams, which suits our investor base, which is more institutional.”

But a key issue for managers and developers will be alignment of interest. Jamie Broderick, board member of the Impact Investing Institute, says: “Social housing needs to attract more equity capital. That’s especially true when there are other financial pressures on housing from decarbonisation and safety remuneration, particularly around cladding.

“You could use more equity, but how do you build a relationship between these parties that is fair and equitable, and that allocates the risk fairly and still provides safe and secure homes to tenants? I would say it’s a negotiation between the fund and the individual housing association.”

Broderick warns that some housing associations remain sceptical about for-profit equity providers. “It means that when equity providers come to the market they have a limited number of housing associations to select from, because not all are willing to engage with the equity provider,” he says. 

Another key issue is rent control. If governments impose unexpected restrictions, then where does that leave investors? Oremus says: “Regulation is acceptable as long as it is transparent and predictable. Investors in the residential space are looking for long-term stable returns, and regulations could be helpful in stabilising the market. It’s important that regulation also works for the supply side.”

Another issue is reputational risk. But industry participants believe that investments that prioritise social value are less exposed. 

Van Doorn comments: “I think investors realise that affordable housing is a political hot potato. Yes, you can decide not to get involved because of reputation or political discussion, but you also have a role to play in society, and if there is strong demand, then maybe we just need to get over it and do it. There’s always political discussions. That doesn’t mean we shouldn’t get involved.”