London And Europe Brace For Impact Of Increased Rent Control
A spectre is haunting the property markets of major European cities — the spectre of rent control.
Berlin and Barcelona have introduced new legislation tightening existing rent control. And London Mayor Sadiq Khan last month outlined rent control proposals that he would like to see introduced in the UK capital.
The reaction of the real estate industry in these cities has been predictably negative. Some influential companies that know the sector think investment in existing stock might not suffer too badly. But the fear is that tighter rent regulation will hinder new supply, and exacerbate the problem it is trying to solve.
It has been exactly 30 years since the UK had any form of rent control: Laws limiting rents that were put in place in 1965 were repealed in 1989. So for all but those with the greyest of hairs, rent control in London is an entirely new phenomenon. And the fear is that it would stop the almost-as-new institutional build-to-rent sector in its tracks.
Khan's outlined proposals would, among other measures, see landlords of existing assets be forced to reduce rents to a "desired level" and limit rent rises within and between tenancies.
Khan would need central government approval to introduce the legislation. He is almost certain not to get it from the current Conservative government, but Jeremy Corbyn’s Labour Party has said it is generally in favour of rent control.
Institutional investment in rented residential is relatively new in the UK, and the sector is booming, with record amounts invested in the development of new assets in the first half of 2019, according to CBRE.
But the British Property Federation said this investment could be curtailed by the prospect of rent controls. It said in a statement after the proposals were announced that measures designed to encourage institutional investors to keep building, such as an exemption period for new properties and potential tax incentives, lacked clarity.
The BPF pointed out that institutional investors exited rented residential investment wholesale when rent controls were last in place.
The biggest developer in UK build-to-rent put it even more starkly: It would cause companies to consider whether it made economic sense to build at all.
“This is very basic economics,” Quintain CEO Angus Dodd told Bisnow. Quintain, owned by Lone Star, is developing the largest rented residential scheme in the UK, with more than 5,000 units, at Wembley Park in North London.
“We are in a world where the delivery of new housing is largely in the hands of the private sector,” he said. “If you restrict and cap rents, then that has a direct economic impact on profit and investment in the sector will reduce, so the supply of housing will reduce."
Dodd said that the introduction of the policy could have a very immediate impact on the development of new stock.
“In the medium term, institutional investors can work within the boundaries of the legislation,” he said. "But in the short term, if suddenly there’s a big change we would struggle with our shareholders to justify building."
Dodd argued that the regulations specifying that a certain proportion of new homes built had to be affordable was a de facto form of rent control.
“For every 1,000 homes we build, 35% of these are affordable,” he said. “So we are already subject to rent control. We are able to do that because the rest of the units are at an open-market rent. If you start restricting those rents, then it has an impact on the delivery of that affordable housing, and the government or local authorities will have to step in."
While rent control is an entirely new form of legislation for investors and developers in London to try and grapple with, that is not the case in the other two major European markets where rent control is being tightened: Berlin and Barcelona.
In those two cities, there are specifics that make rising rents an emotive issue.
Spain is a nation of homeowners, with 77% of households owning their own home. But as with the U.S., Spain embarked on a construction boom which saw huge overbuilding and a resultant housing crash when the 2008 financial crisis hit, causing a huge loss of wealth for citizens. Many homes were repossessed by banks and then rented back to the previous owners, a cause of much social unrest.
In Barcelona, the situation has been exacerbated by the city’s success as a tourist destination. Overnight tourist stays quadrupled from 1990 to 2015, and as homes were converted to hotels and, more recently, rented out on Airbnb, rents have risen 50% since 2013.
Spain’s government passed regulations earlier this year limiting rent rises to the rate of inflation. Barcelona is going further; the local and state governments have the ability to declare a district an “unstable rental market” if prices are rising too fast. Rental increases will then be capped at 10% above an index of average rents.
Berlin is an even more unique case. For 35 years, it has been the world’s most idiosyncratic housing market. The communist eastern side of the city received state subsidized housing at near-zero rents. And the inhabitants of the democratic western half of the city received heavy subsidies to persuade them to live on the small island surrounded on all sides by communist East Germany.
Berlin has become an epicentre of the German tech scene, attracting the second most venture capital investment in Europe after London. It is also a decidedly cool place to live, with young workers drawn by its international outlook, and of course low rents. But as the population grows, rents have increased for the first time in generations, causing a huge pushback from residents.
The city government has introduced new rules freezing rents for five years. The rules will come into force in January, but have been backdated to June to stop landlords rushing through rent raises. This comes on top of existing regulation limiting how much landlords can raise rents during tenancies.
That is not all. Listed company Deutsche Wohnen is the largest residential landlord in Berlin, with 117,000 apartments under its control. The company became a lightning rod for protests about rent rises in Berlin, with a campaign group springing up called Deutsche Wohnen Enteignen, which roughly translates as “Nationalise Deutsche Wohnen.”
The company was created after the German city government sold its portfolio of rental housing units to Goldman Sachs and Cerberus in 2005. The duo later spun off the portfolio into a new listed company.
Now, the Berlin city government has started to buy apartments back. In June, it bought 670 apartments in the east of the city that were about to be sold to Deutsche Wohnen for around €90M.
"Berlin must regain more control over its rental market,” Berlin Mayor Michael Müller said in a statement. "These 670 apartments are a first step in this direction.”
The apartments are on Karl-Marx-Allee, which was the East Berlin street that housed the most important political figures and departments under the communist regime.
One of the largest investors in European rented residential gave a nuanced response to the rise of rent control regulation in the region. Blackstone is the largest investor in rental apartments in Spain, having snapped up more than $10B of distressed loan portfolios from banks in the past five years. It also invests in rental housing in markets like Stockholm, Helsinki and German cities. Rent control regulation does not necessarily deter it from investing, but it might change the way it invests.
“Rent control is not new, it has been in place in various forms for many years,” Blackstone head of European real estate James Seppala said. “Existing rent controls don’t necessarily change our appetite to invest in those cities. They may impact our projected business plan and hold period, and possibly the vehicle we use to invest towards more long-term, permanent capital vehicles. But if we believe in these cities, then we will consider those investments.”
While it may not prevent Blackstone from buying property, Seppala said changes in regulation might have a chilling effect.
“What becomes more challenging is changes to rent control regimes and their unintended consequences, especially changes that make it more difficult to develop or improve units," he said. "Changing regimes make it more difficult to invest in capital improvements and to finance assets for example if a lender can’t predict what the regulatory and therefore valuation frameworks will look like going forward.”
Seppala also agreed with the idea that new supply could be reduced by strict rent control regulations.
“The main problem is a meaningful supply/demand imbalance in several markets, exacerbated by a lack of capital flowing into the sector and lengthy approval timings that sometimes make it more difficult and expensive to build new homes,” Seppala said.
“In the case of cities where changes to regulations alter the income profile of rental housing, supply may be affected. If a developer controls land and building rental housing isn’t the highest value use, then the developer may choose to build something else. Capital is also becoming more global — generally speaking, we find there isn’t enough capital in rental housing around the world, and one would want to encourage capital to come into this sector.”
Germany’s biggest rented residential landlord agreed.
“Freezing prices on a dynamic market has never been the way to solve problems,” Vonovia CEO Rolf Buch said. The listed company is Germany’s biggest rented residential owner, with almost 400,000 homes and apartments.
“On the contrary, further regulation, like the Berlin rent cap, will not produce a single new apartment," Buch said. "Rather, the move would hinder investments in modern, flexible housing.”
For Buch, the answer to the problem lies in speeding up the planning system.
"In my view, there is only one solution to this problem and that is to build, build, build,” he said. “In the short term, we have to build primarily in the cities. In the long term, we need to develop new neighbourhoods and make sure to include the outskirts. Unfortunately, missing building permits and the long periods that the authorities require to process applications are making new construction activity harder than it has to be.”
There are other potential unforeseen consequences. Urban markets would see a big spike in micro apartments, according to Corestate founder Ralph Winter. The company is a major builder of micro apartments in Germany.
The economics of development in a rent-controlled world work for these units, because you can pack more of them in to a site. But that means families or people who need bedrooms for elderly parents would be forced out of the city.
Decades of academic studies show that rent control affects different groups in different ways. It helps existing tenants of rent-controlled buildings, who are then less likely to be pushed out of a district or city because of rapidly rising prices.
But it also limits supply, and so in the long term causes rents to rise, meaning that in the longer term the inhabitants of a city are penalised. That is the scenario a worried European real estate community is anticipating.