This article was originally published in October 2020.
Housing shortages in Europe’s cities are driving a rise in tenant protections such as rent control, but that needn’t be a bad thing for investors
Europe’s best cities are booming. With their active environments, dynamic economies and attractive employment opportunities, people across the continent are flocking to nest in these urban hot spots. Yet the rapid growth poses a challenge: are they providing enough affordable housing for their eager new inhabitants?
In response to this, some cities are turning to rent control as the solution, which is causing alarm among investors. The growth in demand for housing is driven by urbanisation: as cities succeed, they attract more people. The reasons for housing supply not keeping pace with demand are, however, more complex. They include limited availability of land, slow or obstructive planning approval processes, high building costs and practical constraints on construction capacity. With the level of new development failing to match the growth in housing demand, house prices and residential rents have reached levels that people on average salaries are struggling to afford.
Politicians and urban authorities need to avoid cities becoming places where only the rich can live. The rising cost of housing is leading to the exodus of many of the workers essential to a city’s basic functioning – police officers, firefighters, teachers and nurses, to name a few. No longer able to afford to live in the city, they are becoming regional commuters.
Historical returns for European markets reveal that those with rent regulations have not systematically underperformed markets with free rents
To tackle this problem, politicians across Europe are considering various measures. As well as subsidised rents and developments, these include rent controls. The recent introduction of a rental cap and freeze in Berlin has caused uncertainty among investors, who are worried that similar measures will spread to other European cities.
It is easy to conclude that greater tenant protection and more rent control is bad for property investors. Certainly, these measures reduce the short-term benefits of frequent rent reviews, which lead to regular increases in investment returns. But greater tenant protection in residential leases is not necessarily bad news for investment performance.
What’s good for tenants can be good for landlords too. Long or indefinite leases with annual uplifts linked to inflation provide tenants with more predictable housing costs, and that makes them less likely to move out. For landlords, this implies lower operating costs, thanks to fewer changeovers, and lower volatility in their income stream – it’s greater stability all round. Increased tenant protection also encourages more people to rent instead of buying a home, creating a larger market for property investment.
Historical returns for European markets reveal that those with rent regulations have not systematically underperformed markets with free rents. In fact, Sweden – the European market with the highest level of rent control in the MSCI Europe Real Estate Index – has delivered the highest historical return to investors. Some of that return came from selling off assets with low, regulated rents to tenants – but that is only part of the explanation.
The real problem for investors is not rent regulation in itself, but the prospect of rapid regulatory change
So the real problem for investors is not rent regulation in itself, but the prospect of rapid regulatory change. Increasing political uncertainty increases volatility, with negative effects on asset values in the short term. Ideally, changes in the regulatory regime should be left to expert committees rather than political parties.
To work, regulation needs to be fair and consistent. If it isn’t, it will discourage investors and developers from investing in property, and the fundamental problem of undersupply will just get worse. So rent regulation needs to be combined with measures that stimulate the supply of more affordable housing in order to tackle the underlying problem.
A progressive way to boost affordable housing would be for public entities to offer land at discounted prices or on long leaseholds with low rents. Private developers and landowners would then be restricted by certain regulations on rent levels and long-term building maintenance to ensure the housing units on the land are affordable and of appropriate quality. Munich is currently testing this model.
All in all, rent control is not necessarily negative for investment performance in European residential real estate. This is especially true for core investment strategies, where stability is important. For investors looking for income-focused returns today, a net yield of 3% to 4% (with an inflation-linked cash flow and very limited vacancy risk) is very attractive. European residential real estate can offer that if approached in the right way. And with rental regulations, such strategies will typically have even lower income risks. So, while rent control is not a panacea, it need not be a problem for investors either.
