In the global real estate industry, there has been little escape from tales of economic woe recently. But there are still many with money to spend, and given the uncertainty around office, retail and leisure following the pandemic, and factors such as online shopping, home working, and the cost of living crisis, residential property is finding favour with investors. So, for those considering investing in residential property, what are the key factors to consider, and how do they differ around Europe?
A matter of perspective?
Historically the attitude to home ownership has varied significantly throughout Europe. Whilst the UK is often described as a nation of (at least aspiring) homeowners, mainland European countries have traditionally had more renters – in big German cities up to 80% of private homes are rented. Understanding the cultural differences in approach to home-ownership helps shed light not only on the markets for different types of residential property, but also where the balance of power lies between the different players.
Whilst build to rent and other private rented sector (“PRS”) properties play an ever growing role in the UK’s housing mix, continental PRS markets are much more mature. This has pros and cons for investors. On the one hand, this often gives greater market predictability for investors in the mature markets. On the other, within many European jurisdictions there is far greater tenant protection than in the UK – the extent to which that’s a benefit often depends on your perspective.
In France, for example, as well as the need for lengthy legal proceedings to remove residential tenants, even where they are not paying rents, there is the concept of the “trêve hivernale”, or the “winter leniency period”. This is a period each winter, usually from 1 November to 31 March where, even with a court decision permitting eviction, a landlord cannot enforce it. Germany similarly has limitations only allowing landlords to terminate residential leases in special situations, such as default of payment.
Italy, likewise, has mandatory residential lease provisions, and any departure from those by the landlord can be deemed null and void if later challenged by a tenant.
In Germany, though, the prevalence of the rented residential sector can have real advantages for landlord investors. The importance of the market translates into significant voting power – meaning that addressing the needs of renters is a political imperative. For example, the continuing housing shortage means that the German authorities provide subsidies for developers to provide additional housing. This, combined with the stable rental returns, can make residential investment very attractive.
In the UK, as the market continues to mature, the balance of power does seem to be shifting towards tenants. Landlords have been banned from collecting ground rents under new “long” leases of 21 years or more, and further reforms have been promised, to make it easier and cheaper for long leaseholders to extend their leases. And legislation is already under discussion to fundamentally shake up the short term rental market too: introducing minimum quality standards and banning so-called “no-fault evictions”. In a sector where tenants typically occupy their homes under precariously short 12-24 month tenancies, this will limit landlords’ ability to take back possession, and provide longer-term stability for tenants.
One particular issue for investors is rent control, which varies widely for residential properties from country to country. Examples include:
- In Spain, the New Housing Law regulates the rents that large property holders can charge for residential leases. Large property holders are companies or individuals who own more than (i) 10 urban residential properties (or five properties in the case of stressed housing market areas declared by regional authorities) or (ii) urban residential properties with a total area above 1,500 m2. The New Housing Law came into force on 26 May 2023, and states that the rent for new residential leases cannot exceed the most recent rent effective in the last five years for the same dwelling, after applying the rent review. Additionally, rent increases are limited to 2% in 2023 and 3% in 2024, and the Statistics National Institute will create a new reference price index to be applicable to the annual update of residential leases (replacing the General CPI index).
- In mainland France, rent increases during the life of a lease are restricted to indexation, which this year, in the context of the economic crisis, was limited by law to 3.5% for indexations made between the 3rd quarter of 2022 and the 2nd quarter of 2023.
- In Germany, in areas officially designated as having a tight housing market, where a property is re-let, the landlord can only demand up to 10% over local comparable rents.
Rent control isn’t the only form of regulation to be wary of – there are often other jurisdictionally specific regulations investors must take the time to investigate. For example, in the UK the enactment of the Building Safety Act 2022 makes wide-ranging changes to various regimes to ensure the safety of residential buildings, especially from fire risk. Anyone looking to invest in UK residential property therefore needs to appreciate not only the additional complexity there now is around undertaking residential development, but also the potentially significant liability that exists for building owners to carry out remedial works where those are required, the cost of which often cannot be recovered from tenants.
The acute housing shortage in Germany has driven regulations, for example the conversion of rental flats into condominium ownership for certain buildings may be prevented by municipalities if the housing market in a particular area is considered to be too stressed. Perhaps more alarmingly for investors, municipalities have a right of pre-emption in respect of residential properties and development opportunities, and can require a property offered for sale to be transferred to it, or even a nominated third party, instead of whoever the owner is concluding a deal with, and can even demand the price be lowered to market value.
Environmental concerns are also a significant driver of residential regulation in Germany. For example, landlords can no longer pass on CO2 related costs in full to their tenants but are required to bear their share as an incentive to improve the energy efficiency of buildings – in short, the less efficient the building, the greater the share of CO2 costs the landlord must pay.
Not all residential uses are equal
Investment in residential assets covers a broad church of different sub-sectors, such as student, senior living, or co-living. This diversity offers real opportunities to respond to differing market demands which may, for example, vary by location. However, each asset type has its own operational considerations, which are increasingly reflected in differing legal or policy requirements.
A particular concern in Spain at the moment is tourist accommodation, and there are significant restrictions around the ability to use residential properties for tourist purposes – something being talked about more and more in other jurisdictions, such as the UK. Further, often the many different types of residential use are not contemplated in Spanish municipal urban planning regulations, which means that there is inconsistency around the country as to how such projects will be handled by the municipality.
Italy, on the other hand, has specific requirements for leases for some residential types, such as student accommodation, specifying matters such as the manner in which rent is to be calculated, which contrasts to leases for properties such as stately homes or properties of historic value, where the parties have freedom to agree whatever details they want.
In the UK, there is often debate about which use class – if any – a particular residential use falls into, as this can have significant financial implications as a result of different demands around the provision of affordable housing, and other policy requirements. This can mean that two uses which seem very similar are treated very differently for planning purposes.
Looking beyond planning consent
Often the planning consent to deliver residential development is only part of the story, particularly for those interested in development opportunities. Those in the UK will likely be familiar with S106 agreements, and their planning obligations requiring the delivery of infrastructure necessary to make the development acceptable in planning terms. Similar agreements such as the Convenios Urbanísticos in Spain, Convenzioni Urbanistiche in Italy, and Städtebauliche Verträge or Erschließungsverträge in Germany all ensure that the demand on infrastructure generated by development projects is met by those benefitting from the project. This can result in substantial costs, which should be explored thoroughly by those taking on projects.
Likewise, around Europe those providing residential development should not be surprised to find that a proportion of their development needs to be provided as affordable housing. In Spain, affordable housing requirements vary by municipality. For example, in Barcelona 30% of new developments – including complete refurbishment of existing buildings – must be social housing, and this may be increased to 40% in certain cases.
In Germany, investors may have to deliver up to 50% affordable housing, although there are subsidies available for investors in social housing. Once this happens, a rent and occupancy obligation is created for 25 or 30 years and during this period subsidised flats may only be let to those with a valid certificate of eligibility for social housing.
In the UK, like Spain, the position varies depending on where you are in the country, and it’s not unusual for policy to require 35-50% of homes to be affordable housing, and whilst there is usually some flexibility around this on grounds of viability, many local planning authorities are increasingly reluctant to venture too far from their targets.
It’s clear that in turbulent times, residential property can be a really sound investment choice. However, the growing diversity of homes, as well as cultural and legal divergence, means that those considering investment in a new jurisdiction need to do their homework first.