I’m mostly in favor of sensible regulation that helps ordinary working people have a better stab at a decent middle-class life. But this good intention thinking sometimes ends up with noble-intentioned, badly executed ideas. A prime example is affordable housing vs rent controls. I think there is a widespread consensus that for many people – young and old, middle class and working class – housing is increasingly unaffordable. The best way of dealing with this problem is to build more new homes where people need them. A large part of that supply driven solution will need to be government-backed social housing but the private sector has a role to play. In particular, we should have a larger institutional PRS sector in the UK i.e large scale institutional owners of private rented housing. These will tend to be scale operators who can build lots of properties cheaply, build in useful services to the new builds and offer market-beating rents. After much prodding, institutions are now beginning to wake up to this market, but I fear that they could end up running into a roadblock. Rent controls.
On paper, rent controls sound a fab idea. Control the level of rents to affordable levels, even for ordinary working families who don’t qualify for social housing. The only slight fly in the ointment is that rent controls also have a direct impact on supply. Put simply, if you control the market price, the market tends to undersupply. We need MORE new flats and houses, not measures that will mean LESS new properties.
To prove this point we’ll soon have a giant social experiment in Berlin, where the City Council has announced plans for rent controls. Not unsurprisingly this has been seen as bad news for the small number of UK listed funds that invest in this sector, notably Phoenix Spree Deutschland which has collapsed in value from 350p a share to its current 280p.
Over in Germany, local investors have put a great deal of money into three large listed outfits: Vonovia (-26% discount to est 2020 NAV), Deutsche Wohnen ( 28% discount to estimated 2020 NAV) and LEG Immobilien (-14% discount).
The chart below – from Morgan Stanley – breaks out how these listed resi real estate businesses have made their money. As we can see, cheap leverage gives most of the returns while the underlying net yield seems to be between 3 and 4% per annum. Organic rental growth seems to be another major component (between 1.5 and 3% pa) and this will presumably now come under threat from changes in the rental laws.
What’s interesting is that according to a new Morgan Stanley research note – “The growing prospect of rent control (even outside Germany)” by analyst Christopher Fremantle – this move by the Berlin city government is part of a much wider international trend. The table below from the Morgan Stanley report itemizes the various new initiatives. I can only say that I think these “reforms” are misguided and should be replaced by a more determined move to increase new build supply.
|The international rent Control push, according to Morgan Stanley
In Spain: the Catalan Government has approved the decree law to limit rental prices
In the Netherlands. Amsterdam is preparing a new proposal, to be adopted by the end of 2019, to restrict sales of newly built housing to owner-occupiers, blocking anyone who wants to buy the properties for rental (Citylab, 20 March see here).
In France. The French government published a decree on April 5, which brings into force legislation voted in November 2018 (known as the Elan law), which grants cities the right to impose rent control, under certain conditions, as a means to protect tenants. Paris’s city council already approved a measure to introduce the practice in December 2018. (France 24, 5 April, see here).
In US. Oregon became the first state to impose a statewide rent control policy and bills have been proposed in New York, Washington and California that supporters say will protect tenants and allow low income individuals to find reliable housing (WBUR, see here; see also New York Times, 21 June, here).
In the UK. Though no measures are currently proposed by national or local
But my views notwithstanding, it seems that rent controls are the big “new idea” amongst many on the Left. This poses big questions for institutional investors – their big challenge according to MS is finding a balance between rental growth and returns. My sense is that investors might need to lower their return expectations from the 10% level per annum to 8% per annum and get smarter at charging for extras.
Anyway, here’s the Morgan Stanley bottom line:
“ Demand/supply dynamics have allowed some residential property names to benefit from above-inflation rental growth, without accompanying investment/capex to justify it; this could increasingly expose the residential rental sector to political pressure, in our view. Against this backdrop, we think investors in listed residential business will increasingly need to be comfortable that their business models can generate a sufficient, sustainable return on equity to satisfy equity markets (c.10% p.a. we think,) without stretching tenant affordability further. In the UK, equity markets have historically focussed on home-building rather than a rental-driven model, given that it is a higher return on-capital model, and one that is part of the solution to a supply shortage. But for those seeking a more visible lower-volatility rental-driven income stream, we still see a place in equity markets for a residential model that blends rental and development. But increasingly corporates may need to combine rental income with (1) additional services (2) capex-driven modernisation activity; and (3) homebuilding, to drive acceptable returns on capital “