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Most of us are well aware of the benefits that arise from making a place in portfolios for property. The asset class offers steady returns, stable income and low correlations with the bond and equity markets. But while the broad asset class is well known for being an effective diversifier, the particular attractions of residential property are less heralded.
We believe it’s a mistake to overlook the role that Europe’s residential property sector can play in a portfolio. For those who are looking to add a further layer of diversification, European residential property can offer even lower volatility than its commercial counterpart. And as its income is highly durable, residential property also offers high risk-adjusted returns.
A key advantage of residential property is that it isn’t anchored to the business cycle.
A key advantage of residential property is that it isn’t anchored to the business cycle. Population and household growth in major and large cities tends to remain relatively stable throughout the cycle. And residential property is also less affected by technological changes than commercial property – for example, the threat posed to retail property by the growth of online shopping. As we all need somewhere to live, demand for housing is much more predictable than it is for the commercial sectors.
And that demand is increasing. Urban populations are growing fast, particularly in Europe’s key cities, as more people move to the cities from smaller towns and the countryside. As urbanisation rates continue to accelerate, private renting is becoming far more prevalent in Europe’s key cities, and renting is seen as the norm for most people. The major cities are increasingly youthful in terms of their age structure, which in turn encourages faster rates of population growth.
But these are not the only factors driving demand for residential apartments in the major urban centres. The European labour force is becoming more flexible and mobile, and migration from other parts of the world is increasing too. On both a national and international basis, migration is positive for the private rented sector as migrants are likely to rent for several years before buying a property.
Other demographic trends are favourable too. People are marrying later, and the size of the average household is shrinking. That creates a greater need for apartments for single people and smaller families. On top of that, there’s the increasingly prohibitive cost of buying a house, which is resulting in a growing preference for long-term rented housing.
Then there’s supply. The supply of houses and apartments is typically constrained in European cities, and especially in the major urban centres. Housing supply is failing to keep pace with Europe’s rapid population growth, and this has positive implications for long-term rents and capital values. Supply is limited by green belts, the preservation of historic areas, political opposition to development and an increasing shortage of developable sites. Tightening environmental regulations are also limiting the number of new developments, thus further constraining the supply of available housing.
There are particular attractions in Europe’s ‘winning cities’ – urban centres with very strong demand and supply fundamentals. Such cities are found throughout western Europe and the Nordic countries. There is a particularly high concentration of ‘winning cities’ in Germany, given the size of its population and the fact that around half of that population rent rather than own their own homes.
Despite the constraints on supply, tenants in these cities are discerning. In general, they have three main concerns: affordability, accessibility and amenity. This means affordable rents and homes in places that are well connected, with good access to supermarkets and leisure activities. Big institutional investors in Germany know that and build properties accordingly. This makes it much easier to let the properties in the first place and to keep tenants over the longer term. These assets therefore generate a secure income because of multiple leases, minimal vacancy rates and strong potential for rental growth. That creates attractive long-term return streams for those who invest indirectly in residential property.
Finally, besides being a diversifier in its own right, residential property also offers considerable diversification within the asset class. Alongside apartment blocks, the residential sector embraces student halls, which are becoming an increasingly significant investible sub-sector in continental Europe. Then there are serviced apartments, which offer high occupancy rates and high yields, and senior-living and care-related housing, which provides a secure income stream and benefits from Europe’s ageing population beyond the major cities.
Taken together, these dynamics make a strong case for Europe’s residential property market. As well as a source of diversification, residential property is an attractive asset class in its own right: one that harnesses powerful demographic trends and deserves to find a home in a well-balanced portfolio.
The views and conclusions expressed in this communication are for general interest only and should not be taken as investment advice or as an invitation to purchase or sell any specific security.
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