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Rental growth is the lodestar for many residential property investors. This isn’t without foundation, as expanding gross rent is an important driver of investment returns. However, our research shows that a single-minded focus on this measure can be counterproductive. We argue that investors need to balance rental increases with tenants’ happiness, as high levels of turnover can eat away at investment performance.
A key insight from our long experience in European residential markets is that tenant turnover matters.
The reason is fairly obvious, yet often overlooked. Losing a tenant brings a whole host of costs, whether for light refurbishments, fit-outs and repairs, or for outlays for broker fees and advertising. On top of this, there’s the lost rent between tenants. These costs can amount to several months of rent, thus making a real dent in investors’ income and, by extension, asset-level returns. And of the many factors influencing tenant turnover, rental growth features high.
Many European countries have lease regulations that protect tenants by curtailing gross income growth for landlords. We believe these types of policies reduce tenant turnover and, in some instances, boost net rents. Meanwhile, countries with weaker tenant protection, such as the UK, tend to have higher turnover, as well as greater levels of private ownership — as the only real option for long-stay security. Interestingly, this challenges a widely held notion in the UK that forms of rental ‘control’ are unworkable.
Average tenant turnover levels vary significantly from country to country. In Germany, the typical lease duration is close to 12 years, over four times longer than in the UK. In our view, this huge difference is largely explained by lease structure. In many European markets, residential leases are open-ended or very long, with rents linked to inflation. With rental growth in major cities having outpaced inflation, there is a strong incentive for tenants to stay put, so as not to expose themselves to higher rents. By contrast, UK leases are normally fixed for six months to one year. After that, the contract lease will be subject to market terms.
There are other factors that correlate with turnover, including unit size and residential type. For example, students and young professionals tend to rent one bedroom apartments and generally place a greater premium on flexibility. This is reflected in a comparatively high turnover ratio in this category — including in Germany — which landlords compensate for through higher rents per square metre. Conversely, in the case of family housing, tenants normally stay much longer.
Besides these variables, tenant satisfaction is of course also a function of the quality of the accommodation, including adequate maintenance and good services. Indeed, amenities such as concierge services, fitness facilities, parcel pick-up and tenant apps are becoming increasingly important in promoting tenant contentment.
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. 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 in high-turnover markets, such as the UK. Again, there are structural reasons for this, but we believe the general principle holds across markets. So rather than blindly trying to maximise rents, investors should focus instead on keeping tenants happy.
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