Creating a virtuous circle in residential investing

How tenants, landlords and the planet can happily co-exist

How do we balance effective residential investing with being sensitive to tenants’ needs and to climate change? With the right approach, these goals can be far more harmonious that you might think. In fact, we would argue that they are intrinsically linked.

Using change as a lens

We have identified four global forces for change that we believe will shape the future. In turn, they will also shape our long-term approach to how we prioritize environmental, social and governance (ESG) factors. The four forces are:

  • a changing environment and climate;
  • increasing governance, engagement and calls for transparency;
  • changing demographics; and
  • rapidly increasing technology, connectivity and infrastructure.

If we look at residential assets using these forces as a lens, we not only see the form and function of the asset, but also how it fits within its wider environment. We can see what social value a property brings to the community. And, most importantly, how the occupier uses and engages with the space.

Happy tenants make business sense

A key insight from our recent “happy tenant = happy landlord” research showed that tenant turnover matters. Understanding and providing what tenants want and ultimately seeking to retain tenants makes sound financial sense. The reason is fairly obvious, yet often overlooked: losing a tenant brings a whole host of costs. These costs can be for small refurbishments, repairs or for outlays such as broker fees and advertising. On top of this, there’s the lost rent between tenancies. These costs can amount to several months of rent, thus making a real dent in investors’ income and, by extension, asset-level returns. Of the many factors that influence tenant turnover, increasing rental and occupational costs are a couple of the most significant. Clearly, keeping tenant turnover low makes sense, which in turn suggests that chasing every opportunity for higher rental growth might not.

Tenant satisfaction is, of course, a function of the quality of the accommodation, including adequate maintenance and good services. However, it is also a function of the amenities that are available, such as concierge services, fitness facilities and parcel pick-ups – all of which are becoming increasingly important in supporting tenant contentment. We are also finding that more intangible aspects also come into play, such as health and wellbeing considerations in the design and operation of the asset. For example, providing more natural light and good air quality are important. And ensuring use of low-volatile-emitting materials in construction makes a difference in the rent-ability and attractiveness to occupiers.

But a building is more than just bricks and mortar. It also serves a social purpose, especially in a multi-family residential building. Our industry needs to move away from thinking of itself as a remote landlord and move toward acting as a steward of the community. Health, inclusivity and mental wellbeing are not words normally associated with residential landlords. But they should be, as they are key to promoting tenant contentment and satisfaction.

The link to investment performance

While this all makes sense, demonstrating a clear link to investment performance is more difficult. For example, would a building with higher ESG credentials achieve higher rental growth or income? There is very limited research and literature available on the financial effects of green multi-family residential buildings from a landlord´s perspective. IN the US, research (Hopkins, 2018) suggests that multi-family properties with green certification have a significant rental premium to properties without such certification. The research also suggests, perhaps counterintuitively, that these certified buildings have higher operating costs. However, the level of rent collected is substantially greater than the higher costs. While this research is interesting and might make sense for some investment strategies, it runs counter to our view as a long-term investor. Developing higher ESG standards should not be seen as a chance to chase higher rents, but rather as an opportunity to reduce tenant turnover and to keep those hard-won tenants for longer.

If operating costs go down, income can go up

Our experience hasn’t shown clear evidence of a rental premium on these assets. But we have found anecdotal evidence that tenants do value energy efficient buildings, which can improve the asset’s attractiveness and implies that residents will stay for longer. Put simply, if we can provide a home with lower utility costs through better efficiency, then this should lead to greater affordability and attractiveness for the tenant. The total cost of occupation for the tenant normally equates to rent plus operating costs. If we can reduce the operating costs, then there is more scope to maximize rental income without increasing the total cost of occupation for the tenant.

Keep turnover low to maximize income

Furthermore, our research into the relationship between tenant turnover and rents points in a direction that may be counterintuitive for some investors. But the arithmetic is clear, particularly when viewed as a long-term investment. The benefit of a higher gross rent can be negated if it brings increased tenant dissatisfaction. All else being equal, investments in low-turnover markets, such as Germany, will generate much better net income than high-turnover markets, such as the UK. Again, there are structural reasons for this, but we believe the general principle holds across markets. Rather than blindly trying to maximize rents, long-term investors should focus instead on keeping tenants happy in order to keep them in the buildings longer.

If we take a broader view of ESG and take into account longer-term ESG risks like climate resilience and climate transition risks, then there is a strong argument that we are ensuring a more resilient and durable income stream from our assets. It no longer seems altruistic to have a portfolio of residential assets that are designed to meet long-term climate targets and to manage the wellbeing of its occupiers. It actually makes commercial business sense to do so. If done correctly, investing in residential assets can create a virtuous circle with a happy tenant, landlord and planet.

IMPORTANT INFORMATION

Property investments may carry additional risk of loss due to the nature and volatility of the underlying investments and may not be available for investment by investors unless the investor meets certain regulatory requirements. In considering the prior performance information contained herein, potential investors should bear in mind that past performance is not necessarily indicative of future results, and there can be no assurance that such investments will achieve comparable results.

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RISK WARNING
The value of investments, and the income from them, can go down as well as up and you may get back less than the amount invested.

AAM Group