As this protracted business cycle stretches on, real estate asset classes underpinned by structural factors that protect their value in the event of a downturn are looking more and more appealing to many investors. That is a trend that has supercharged interest in logistics and residential property.
Logistics has just experienced one of its best-ever years, but investing at scale in the smallest of the four main asset classes is a perennial difficulty. By contrast, residential property constitutes around three-quarters of the world’s real estate stock, so scarcity is less of a concern, even though the institutionally investable element of the asset class, chiefly rented multifamily apartment blocks, makes up only a small proportion of the total. Meanwhile, the mega-trends driving demand for the asset class are at least as favourable as they are for warehousing.
“Rental residential is primarily driven by demographic demand as opposed to the business cycle or business expansion. That makes it a stable investment perfect for institutions at a time when investors are starting to think more conservatively about their portfolios, and which lends itself to more recession-resistant asset classes,” argues Bob Faith, founder and chief executive at residential real estate company Greystar.
“Urbanisation means jobs are being created in the cities and population growth is occurring there. Combine that with dramatically increased mobility of the population and it leads to a desire for less permanence in housing choices, which leads to renting rather than owning.”
Furthermore, even those who would like to buy are increasingly unable to do so: “We see multifamily housing as a forced rental story,” says Jeremy Plummer, global chief investment officer at CBRE Global Investors. “Affordability challenges for home buyers are not going away, so there is growing rental demand in urban areas all over the world.”
Some investors also see residential as a way to tap into the economic upside of fast-growing cities. “The demand for multifamily in those markets is very much driven by job creation, so it is a way of responding to markets where we think local economies will outperform compared with their domestic markets in general,” says Hilary Spann, head of real estate investments for the Americas at the Canada Pension Plan Investment Board. “For example, in the US we have large investments in multifamily in the Bay Area around San Francisco.”
There is “enormous demand” from investors for the asset class globally, claims Faith: “When you look at the history of returns in rental housing versus other asset classes, the returns are as high or higher but there is a lot less volatility.” According to Real Capital Analytics, $11.21 billion was raised for pure residential strategies globally in 2018, a substantial increase on the previous year’s figure of $8.92 billion.
When it comes to selecting strategies to access the sector, many investors still start with the US, which remains by far the largest and most mature rental housing market. Jeanette Rice, head of multifamily research for the Americas at CBRE, calculates that in 2018 multifamily investment volumes totalled $172.6 billion, a 19-year high. “Multifamily was the top sector for property investment for the third year in a row. The appetite from domestic institutions and foreign capital is very strong.”
Equity seeking a home in the US multifamily market has increased the volume of development, says Tim Wang, head of investment research at New York-headquartered manager Clarion Partners, but the growth of demand has kept pace. “At the end of 2018, the nationwide average vacancy was only 4 percent, a cycle low. New supply is high, but most investors overlook the demand side of the story, which is at a record high. That theme will continue in 2019. The reason is that the 79 million in the millennial generation is the largest in US history, bigger than the baby boomer generation of 75 million, and they will stay in the rental cohort for a longer period of time, for both social and economic reasons.”
Europe’s multifamily investment market is smaller, and has historically been focused on Germany’s large rented housing sector – transactions totalled $57.9 billion in 2018, according to RCA – but it is growing, says Marcus Cieleback, group head of research at German investment house Patrizia. “Since the financial crisis, ownership rates across Europe are declining. There is now a large number of households that have purchasing power and will make attractive tenants. They are a target group for institutional residential investors in markets like the UK, Ireland and Spain, which have not traditionally been multifamily markets.”
Cieleback observes that some pan-European investors have been talking about investing in residential for years, but have only started to do so in a meaningful way in the past six to 12 months. They will benefit from “quite attractive” returns in the coming year, he predicts. “Income returns will be between 3 to 4 percent unlevered plus capital growth of 1.5 to 3 percent unlevered. Levered you can get 7 to 8 percent total return.”
In Asia, China offers the potential for first-mover returns as the government moves to facilitate the creation of rented residential, but the most mature institutional market remains Japan. “One of the attractions is that debt costs are extremely low so you can earn attractive cash-on-cash yields from a very stable asset class,” says Plummer. “Rents are growing slowly but steadily in Tokyo, which has a growing population despite the demographic headwinds for Japan overall. If you are looking for 6 to 7 percent total return, most of which comes from income, it is pretty attractive.”
While traditional multifamily is still the bread-and-butter of the residential investment sector, recent years have seen the emergence of a variety of sub-sectors like student accommodation, various forms of senior living, co-living, micro-living and serviced apartments.
For some managers, specialisation is a key element of their approach to the sector. Thomas Landschreiber, founder and chief investment officer of Luxembourg-based manager Corestate Capital, says his firm’s range of strategies seeks to satisfy customers’ needs for rental accommodation at various stages of their lives: “We try to follow the demographics and our tenants – from student homes, to apartments for young professionals, normal residential, serviced apartments for when they travel for business, and lastly, we will develop a silver-age product for when people want to leave their big family house and move back into the city.”
Co-working is the office market’s hottest trend, but while co-living – smaller apartments with more extensive communal spaces for socialising – has received plenty of publicity, so far there have been relatively few such developments. Nevertheless, Landschreiber “strongly believes” in the concept. “In two to three years I am pretty sure it will become an asset class on its own,” he predicts. “As that happens, we will see cap rate compression in that sector just as we did in student housing when it became established.”
Other observers are less convinced of the scope such sub-sectors provide for long-term growth. “Student housing will remain an important part of the residential universe, but a less important one than many people expect because in European countries outside the UK, a lot of students will go into the general rental market when there is accommodation available,” argues Cieleback. “New concepts like co-living might be interesting for students and young professionals in some cities, but it is an add-on to an existing market and not something I expect to be hugely important going forward.” However, he adds that he too thinks that early movers may be able to capture some capital growth in emerging niche markets.
Bubbles of supply
Residential real estate has become established on many investors’ wish lists, but could anything derail that enthusiasm for the space? Investors must always keep a watchful eye on political developments that might drive regulatory change, suggests Bill Hughes, global head of real estate research and strategy at the real estate and private markets division of Swiss investment bank UBS. “In the late 90s, the policy to make capital more available for homeowners in the US diminished the multifamily sector for a decade,” he recalls.
Robust tenant demand for rented accommodation does not guarantee a profitable investment, cautions Andrew Allen, head of global property research at asset manager Aberdeen Standard Investments. “Investors need to be clear they have the entry price right because the yields are relatively tight. Quality of design, services and layouts are incredibly important in terms of long-term investment performance. If you get that right, it can really improve the gross-to-net efficiency of your assets. Get it wrong, overpay, and it could run away from you.”
Meanwhile, old buildings may be at risk of obsolescence due to evolving tenant demand, says Tom Shapiro, founder of US investment manager GTIS Partners. “People are willing to sacrifice unit size for more common spaces, and it is very hard to adapt some of the older multifamily buildings to what is wanted today.”
Faith warns that “bubbles of supply” have developed and are outstripping demand in some sub-markets where development has been rife. “There are also markets like the San Francisco Bay Area where affordability is starting to become an issue. Even if there is not much supply, rents cannot continue to grow without incomes also growing,” he adds.
Most market observers will agree those are relatively modest caveats, however. Everyone needs a roof over their head, and fewer people can afford to buy, so residential real estate in growing urban areas around the world looks certain to exercise a powerful fascination on real estate investors for years to come.