European residential investment volumes stood at €15 billion in Q3 2021, up 28% on the same period of 2020. It takes year-to-date investment to €50 billion.

Institutional investment into residential assets, encompassing student housing, multifamily and single-family rental, co-living and seniors housing, has accounted for 25% of all real estate investment by value across Europe so far in 2021, only behind offices. Ten years ago, the residential sector accounted for just 10% of all European acquisition activity.

This uptick in investment has been underpinned by the defensive characteristics of the sector, which have been on display during the last 18 months, as well as investors’ growing comfort level with exposure to more operational real estate.

With inflation on the rise and bond yields at historic lows, the defensive benefits of investing in beds are set to continue as investors look to rental income as a hedge against inflation.

Germany was the largest market for residential investment in Q3, capturing 39% of total European investment in the sector, followed by the UK, Demark, Sweden and France. Cross-border capital, meanwhile, has accounted for almost half (46%) of purchases so far, up from 41% during the whole of 2020.

As governments continue to gradually lift Covid-19-related restrictions and cross-border mobility improves, we expect pent-up investor demand for European property to translate into a further rise in transaction activity in 2022 and beyond.

This view is supported by Knight Frank’s survey of 22 institutional investors currently active in the sector who, combined, currently account for €64 billion in residential assets under management across Europe. The results suggest they plan to invest a further €19.5 billion in 2022 and €87.5 billion over the next five years.

Survey results

Operational residential real estate has proven to be resilient despite wider macro-economic uncertainty, with data suggesting that both occupancy and rent collection rates have remained high throughout the pandemic.

In the UK, for example, the survey of some of the biggest investors in multifamily found rent collection levels have stayed above 95% since March 2020. This resilience is due to strong underlying fundamentals. Affordability and increasing urbanisation, as people move for work and study, continues to drive demand for rental accommodation, whilst ageing populations mean there is a need for purpose-built accommodation across age groups.

Accordingly, the sector continues to grow rapidly throughout Europe and we expect allocations to residential will increase markedly over the next five years.

Some 91% of respondents to the survey noted they plan to significantly increase their allocation to residential over this time. A number of investors who may only be active in one or two residential sectors today said they plan to become active in additional sectors by 2026.

Currently, just 18% of respondents invest across all the residential sectors in Europe. In five years’ time, this is expected to rise to 45%.

This echoes Knight Franks’s expectations for increased diversification within the residential investment market, with investors spreading their exposure across age and lifestyle groups. While there are significant differences in market drivers, there are also synergies – particularly with regards to construction and operations – which makes the decision to move across sectors more appealing.

Where will capital flow?

The survey respondents identified the countries where they saw the best prospects for investment over the next five years. Germany, the UK and Spain were cited most often by respondents across all sectors, suggesting an overlap of the different drivers for each sector to provide a favourable investment environment – from strong student demand, the presence of large-scale regeneration and development as well as strong employment conditions, or a lack of seniors housing units. Newer markets also featured, with Italy, Ireland and Poland expected to attract a greater share of investment.

Some 55% of respondents indicated they believe the residential investment sector will outperform all other real estate sectors in 2022. When asked which residential sector specifically was most likely to outperform in 2022, survey respondents suggested that student accommodation would narrowly beat the multifamily and single-family rental markets.

The availability of operational stock was cited as the biggest barrier to increasing investment, followed by unrealistic yield expectations and increasing competition from other investors. This is unlikely to change in the near term given the significant amount of capital waiting to be deployed. The result of this ongoing imbalance between supply and demand will be more investment into development projects, leading to some investors having to readjust return requirements.

Currently, just 46% of survey respondents are targeting land deals, with the majority looking for income-producing assets (86%), forward funds (82%) or forward commits (73%), repositioning opportunities (68%) or joint ventures (68%).

Reflecting the growth of the sectors in recent years, competition from other assets classes, maturity of markets and the length of development periods were cited as key barriers by just 9%, 14% and 18% of respondents respectively.

Regulation and affordability top risk factors

The residential sectors in major urban centres are characterised by a structural undersupply of housing, which has underpinned rental growth over the past few years.

The other long-term trends that have underpinned the residential sector’s ascent are also unchanged, despite recent events. European cities continue to grow with the share of people living in urban areas outpacing overall population growth.

Elsewhere, shrinking household sizes and rising house prices have been driving demand for rental accommodation. Data from the OECD suggests that nearly 80% of housing markets within the European Union have seen house price-to-income ratios widen over the past five years.

There are perceived challenges though. Changing regulation, including those linked to zoning and tenancy rules, and rent controls were flagged as potential risks, while affordability has also become a critical issue in many markets. Rising development and operational costs are also likely to be impacting on viability.

Going green

Some 68% of respondents to the survey ‘strongly agreed’ when asked whether ESG is driving strategic decision making. The survey indicates that the driving force behind the demand for green buildings is coming from investors, with 86% of respondents saying this group was ‘very important’ when it came to decisions around ESG. This was followed by regulation at 55% and occupiers at 27%.

As more and more investors consider ESG as key criteria in underwriting investment, demand and therefore the liquidity of buildings with green ratings is likely to increase. Green-rated buildings are more likely to be future-proofed against potential legislative changes, as governments embed carbon targets into law, as well as to shifts in tenant sentiment and preferences.

Longer-term, this may also drive value. Some 50% of respondents said they strongly agreed that ESG credentials would create a value premium for assets.

Post-COVID design considerations

Changing tenant requirements post-pandemic will have an impact on scheme design and business strategy. Demand for more communal and outside space, a place to work from home as businesses embrace remote working and the curation of community within new developments are all expected to rise in importance. However, changes to scheme design will need to be balanced against the cost and viability considerations flagged as potential risk factors in the survey.