Global residential real estate: the opportunities and risks
Rented residential real estate has historically delivered strong capital growth and a robust income stream for its investors. The drivers behind the attractive performance have mainly been fundamental and long-term, rather than cyclical. Our view is that these drivers are still in place, and we see good opportunities to achieve solid risk-adjusted performance from global residential markets in the future.
Population growth outstrips supply
The reason for the strong performance over a long time period is simple: population growth has been stronger than the development of new housing in major cities across the globe, leading to undersupply. Not only does the rate of urbanisation exceed that of completions, but the urbanisation is typically in favour of smaller household sizes, which implies that the existing supply does not always suit growing demand. We are also seeing a rapid increase in the expectations of modern renters, specifically with regard to the design and energy efficiency of the buildings. In many cities, a significant share of residential development has focused on more expensive, owner-occupier housing – not housing that the average paid worker can afford. This is becoming a social and political challenge in large cities across the world.
Challenges in the residential sector
While much of the current real estate news focuses on forms of technology-related disruption, the fundamental observation is that residential is not as susceptible to the same changes. After all, an individual has a basic set of needs in a home and a minimum space requirement. After that, the requirements rise with affluence – as people earn more, they want more.
While the fundamentals are strong and the risks of disruption are low, there are several challenges when it comes to building cross-border residential real estate exposure. Local market practices, ownership culture, taxation, the size of investible stock, tenant protection, and lease regulations are all much greater for residential than for the major commercial sectors. As such, local expertise and efficient management are needed to be successful in a highly competitive residential investment market.
Look after your tenants
Our recent research shows that the longer residents stay, the greater the operational efficiency for the investor.
Our recent research shows that the longer residents stay, the greater the operational efficiency for the investor. Treating our residents well makes good business sense, rather than constantly trying to achieve the highest gross rent. Our German tenants, for example, might stay with us for perhaps eight to 10 years and yet our UK residents stay for just 18 to 24 months. The higher turnover in the UK reduces the net income that an investor receives. Our experience shows that the higher turnover-related costs in the UK aren’t always compensated for by higher growth in market rents. It’s extremely important to understand such international differences when investing in cross-border residential.
Our international experience influences our management approach in less-developed residential investment markets like the UK. It is very clear that modern, well-designed and well-managed residential blocks have materially lower risks and stronger prospects of net operating income than older, smaller and less well-designed buildings.
Growing interest in residential
House prices in global winning cities have increased strongly. The price difference per square metre of residential use, compared with secondary offices or other commercial properties, has widened significantly – to levels that are often higher than the cost of conversion.
Our recent global investor survey on residential makes a clear observation around the level of interest in the sector. Some 42% of respondents stated an intention to increase allocations to residential. These investors typically look for a core, low-risk exposure to the income stream, with prospects of real income growth over the long term.
In a very competitive investment environment with high demand for residential assets, local insights in the stock-picking process are essential. A strong focus on management efficiency, to reduce the leakage between income received from tenants and the dividend paid to investors, is also vital.
A version of this article was published in Finanz und Wirtschaft during June 2019
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