Investors in the European housing market are, for the most part, either homeowners or governments. A few are corporations that built large swathes of housing for their own workers after the second World War.
But now there is growing institutional investor interest in rented, residential real estate, a sector that comprises roughly a quarter of all publicly held real estate in the US.
A new report from property consultancy FPD Savills concludes that the main barrier to such a sector arising in the UK is the absence of new investment opportunities: "Money is not so much an issue at present . . . the biggest problem facing investors is actually sourcing suitable stock." Much of the rented residential sector in the UK consists of the so-called buy-to-let market, mostly a wide range of individual investors who have purchased and refurbished properties and are renting them out as private landlords.
Given the forecasts of 3.8 million new households to be formed by 2021 - of which a considerable minority will consist of single people - the existing rental market is inadequate for future needs, FPD Savills says. "The problem with the buy-to-let market is that it is not really adding sufficient quantities of the right kind of product in the right place to satisfy the profile of future rental demand." What is needed, the group says, is a product such as "the corporately run letting blocks of North America".
By all accounts, North American residential real estate is a profitable sector. According to data from Nacreif, compilers of the most robust index of US property returns, investment in apartments outperformed all other properties in the years 1984-1996. Between 1985-1998, apartments had average annualised returns of 8.6 per cent against 6.5 per cent in aggregate for all other property types. The sector is dominated by about 30 corporate owners of rental apartments who own between 10,000 and 250,000 units each.
However, a recent report from analysts at Green Street Advisors, a California-based real estate securities research firm, suggests that operating apartment chains may not be as profitable as general wisdom suggests.
In a report in April, Green Street pointed out that unleveraged returns of apartment REITs (Real Estate Investment Trusts), even when capital appreciation is taken into account, are only 11.0 to 11.5 per cent. "These less-than-stellar returns steer us to the conclusions that much of the reported net operating income (NOI) growth is being `purchased' with capital investments and that the level of cap-ex reserve necessary to merely maintain competitiveness is very high."
The implications of ongoing capital expenditure have relevance beyond the fiercely competitive US marketplace, says Keith White, managing director at Savills residential management.
Mr White, who manages about 5,000 rental units around the UK, says continuing maintenance costs are those most consistently misunderstood by investors. Costs per apartment will vary widely depending on property type and age, but when added together with debt service and other management costs these can total anywhere from 20 to 50 per cent of annual NOI. Green Street notes that in the US, with its more substantial rented apartment sector, there is scope for wide variation in costs per unit, leaving aside ongoing capital expenditure. Mike Kirby, principal at Green Street, notes that local taxes alone are such a significant factor they obscure comparisons between companies. But getting at the size of actual cap-ex is a very thorny issue, Mr Kirby says.
Green Street highlights a submission to the US Treasury from the National Multi Housing Council - a trade association of apartment owners that includes many large apartment REITs - seeking a shorter depreciation schedule on assets. The group wants the faster schedule to allow its members to write off more expense in each year, thus lower reported profits are paid. A supporting study, intended to buttress the case for faster depreciation, concludes that building equipment comprises 35 per cent of value and that the majority of items in this category have lives of 20 years or less.
Mr Kirby says that what is so disturbing about the NMHC's plea for tax relief is the contrast with the quoted companies' estimates of how high their capital expenditure reserves ought to be.
Green Street's own estimates of cap-ex are around 60 to 70 basis points of return, much higher than those of other REIT analysts. But using the NMHC numbers would take a further 150 basis points off apartment returns. Mr Kirby says the NMHC numbers are probably inflated for lobbying purposes. "There is such a gap (between these and the companies' own figures) that it defies imagination," he says.
If the NMHC numbers are correct, he says, it would place combined maintenance and cap-ex costs for an apartment complex at $2,000 per unit, twice that estimated by Green Street.
The concern is that expenditure for ongoing repairs and maintenance is disguised in the capital reserve for the entire building. Investors are thus kept in the dark about the true profitability of apartment companies. And without that information, institutional investors cannot know whether or not apartments are a good bet.
