26 June 2024, Amsterdam – In 2023 institutional investment in residential real estate hit 22.7% as a share of total assets under management (AUM) within the INREV Annual Fund Index, up from 6.6% in 2013, according to new research published by INREV. It has moved from being the smallest to the largest major sector across single sector funds while office and retail have contracted. At the same time residential allocations in the multi sector funds have also notably increased. The findings from the ‘Unlocking affordable private rented sector (PRS) to address the twin challenges of housing need and decarbonisation’ paper paint a clear picture of strong interest in the residential sector from institutional capital, which has continued to accelerate over the past decade. Institutional investors and mangers continue to be eager to invest in the intermediary affordable private rented sector where it aligns with their financial objectives and their fiduciary duties to pensioners and savers. Their current and future allocations to residential PRS are also playing a key role in addressing the two pressing societal challenges of an acute housing shortage and the urgent need to decarbonise.
Focused on affordability
According to the new paper, market participants are highly focused on intermediary PRS strategies that are centered around delivering rented tenure housing for middle income socioeconomic households at a rent that is economically sustainable and therefore affordable for tenants. Many recognise the impact of key structural shifts in housing markets across the world where middle-income households are increasingly being squeezed out of owner occupation because of ever-higher prices and mortgage costs.
Significantly, 94.1% of institutional investors and managers say they invest in the intermediary / affordable segment of the residential sector. More than half (52%) indicate that this segment accounts for over 50% of their residential AUM. A further 30% include social or cost-rental housing in their residential AUM.
The report reveals that over half of investors and managers aim to set their target rental levels at a discount to market rent. Almost 50% factor total occupancy costs (including, utility bills and local property taxes) into their calculations, targeting rents below 40% of gross median household income on a localised basis. Sixty percent aim for target rents of less than 30% of gross median household income.
However, investors and managers highlight the need for more policy interventions to level the playing field for the provision of affordable housing. This is particularly important in markets where there are competing opportunities to provide for higher income households, or where limitations on land use and/or density make it challenging to deliver affordable rents.
Between 25% and 29% of market participants say some form of intervention or public-private strategic framework – such as tax breaks, lower cost of capital, accelerated planning, public grants or public co-investment – is essential to the viability of their investment in affordable housing. And 94% see such interventions as important.
Decarbonisation is a key priority
Most market participants consider decarbonisation as a key priority and view it as an essential capital investment that will deliver both positive environmental and economic outcomes. Sixty three percent (63%) say investment in decarbonisation is not secondary to their financial objectives, and over half (57%) see it as a significant driver of financial performance over the long term.
The paper outlines how decarbonisation measures reduce energy, cost and price volatility. This has the potential to optimise rental affordability which, in turn, can increase returns for investors, thus maintaining the desperately needed influx of capital to help ease the structural shortages of housing across most European markets.
However, the current constrained market conditions mean some investors and managers are being forced to delay capital expenditure on decarbonisation in order to preserve value. The paper identifies that in the absence of regulation or the introduction of more punitive carbon pricing and a valuation process that at best reflects the price a buyer is prepared to pay; investors and managers are trying to balance short- and long-term fiduciary duty and returns.
Again, market participants are calling for policy and regulatory intervention – such as carbon pricing –to better reflect the real value of high carbon assets. Over half (57%) agree or strongly agree that some form of assistance is required to support the cost of decarbonisation associated with affordable housing.
Iryna Pylypchuk, INREV’s Director of Research and Market Information, said: “The insights from this paper are extremely valuable in highlighting the significant contribution that the real estate investment industry is already making to address two of the biggest challenges of our time: the global housing crisis and the climate emergency. What’s clear is that institutional investors and managers want to do more, but they need greater support at the policy and regulatory level. Indeed, over half of the respondents consider some form of public sector subsidy to be an important driver of investment strategy in terms of both the macro scale capital allocation by country and the more micro scale site selection. So, for any policymakers seeking to harness institutional capital to help solve the desperate supply shortage of environmentally sustainable and affordable housing, this paper should be a valuable reminder to engage.”