Why rental clarity, not control, is key for BTR growth

Over the past decade, a professionally rented residential sector has been growing in the UK. Boosted by a new generation that is largely unable to find its way onto the first rung of the property ladder, and one that is increasingly comfortable with a rented – or subscription-based – lifestyle, the build-to-rent sector in the UK has delivered record years of investment, year after year. In 2022, some £4.2bn was invested in the sector according to Savills – the fourth year of record figures. But with the constant threat of rent controls being put in place and an extension to September of emergency rent control powers in Scotland that were due to end this month, could investment start to cool? Here, EG turns to the well-established German market to see how investors there are navigating a highly regulated sector. Germany is one of Europe’s largest rental sectors, with nearly 60% of the population choosing to rent – from either private landlords or the country’s burgeoning institutional rental sector. Security of tenure For most investors, clarity seems to be the biggest benefit of the German market. The country’s rented sector, which was established around 60 years ago, has always been regulated. Rent controls were implemented at its inception, with “strict and stable” rent regulation prevalent for decades. Marcus Cieleback, chief urban economist at Patrizia, which has around 27% of its €57bn (£50bn) of assets under management invested in residential, says: ”In Germany, rent control started very early. It was never a completely liberal rental market, so it gave tenants security of tenure. “Tenants theoretically have an unlimited tenure if they rent an apartment. The contract runs are unlimited unless tenants are possibly not paying or there are special circumstances. So, it’s very complicated to kick a tenant out if they are behaving properly.” Until relatively recently, the rental process in Germany was very fair, says Sabine Georgi, executive director at the Urban Land Institute in Germany: “In the past we had quite balanced regulation, which helped to create peace between landlords and tenants. “On the one hand, as a tenant you have the right to stay in an apartment forever, and on the other hand the landlord has the right to increase the rent during this period.” But that changed in 2015, when Berlin authorities tried to prevent large increases in rental costs by introducing a rule that said landlords could not increase rents by more than 10% above the current neighbourhood rental index – a price set by the local government. Then in January 2020 the Berlin authorities went even further, stating that rents in the city for properties built before 2014 had to be frozen at June 2019 levels and that any landlords charging more than 20% over “acceptable” levels should repay the excess. Georgi says the new controls led to an imbalance in the market, and that investment in the sector shrank as a result. By 2021 the measures were overturned by Germany’s courts, the rent freeze was lifted and landlords could reclaim any lost rental income. It was an example of taking rent controls too far – and a clear lesson for the UK to learn from. Long-term play Having security of tenure and clarity around income can be hugely beneficial for investors, however. Back in 2019, analysis from Abrdn found that German rental stock could provide around 10-15% more income net of cost than a similar asset in the UK. For Abrdn – at this point in its ownership – the clarity of a long-term rental agreement and the ability to track and forecast an inflation-linked rent culminated in a steady, controlled income. A dream for an institutional investor. Olafur Margeirsson, head of global real estate research at Credit Suisse Asset Management, which through its Doma platform aims to amass a €1bn pan-European portfolio focusing first on Germany, agrees. Working with private equity real estate investment manager Mark, the firm has already bought 700 units across Germany and the Netherlands. Margeirsson says that transparency and predictability of rents are important to “anchor and drive long-term rental demand”. “The longer a tenant stays in a flat, the lower the administrative burden and costs of operating it,” Margeirsson says. “Offering long-term rental contracts with predictable changes to the rent may therefore be the right strategy for some properties, rather than shorter-term oriented leases.” To Margeirsson, rent controls force better – and perhaps smarter – behaviour from investors. He adds: “Offering predictability on rents requires investors to act accordingly when they finance their investments. High loan-to-value ratios and exposure to swift changes in interest rate costs can become a serious problem if they cannot be mitigated by raising rents. “Investors should therefore be open to using low leverage ratios to boost the resilience of their cashflows and balance sheets, especially because apartment rental yields tend to be low compared with other commercial real estate sectors. Consequently, the focus needs to shift towards generating long-term, sustainable profits, instead of leveraged profits over short time horizons.” That shift to patient capital looking for longer-term profit, instead of a short, sharp bang for a buck, was exactly the sales pitch behind the UK’s push for a professionally rented residential sector. Perhaps a measure of balanced control around rents and tenure, inspired by the German market, could be just what the UK’s BTR sector needs to blossom and boom even further. 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