Investors’ Housing Bets Are on Shaky Foundations

Big property investors turned into homebodies during the pandemic. Rising interest rates will make it harder for them to keep sheltering in housing.

Just as some home buyers are still willing to pay record prices, investors continue to plow large sums into residential property. Since January, they have spent roughly $103 billion on U.S. apartments, following an unprecedented $319-billion splurge last year, according to MSCI data through June 20. Institutional buyers see it as a steady bet, especially since remote working has made it riskier to own offices.

Rent growth in the U.S. has been extraordinary lately. In 2021, rents for professionally managed apartments rose by almost 12%—more than triple the average recorded in the five years preceding the pandemic, according to Harvard University’s The State of the Nation’s Housing report, released Wednesday. As of mid-June, year-over-year rent growth continued at around 10%.

This has encouraged investors to pay high prices. As U.S. apartment values have risen, capitalization rates—a common measure of commercial property returns—have fallen to 3.8% today, from 4.7% before the pandemic, data from

Cushman & Wakefield

shows. Meanwhile, the industry’s cost of debt is rising, as are landlords’ insurance and utility bills.

In Europe, buyers are becoming warier. Investment in the region’s apartments has slowed to $24 billion this year after reaching a record $112 billion in 2021. Regulations and political tensions over housing costs in important residential markets such as Germany will probably restrict landlords’ ability to raise rents in line with inflation.

Despite forecasts for a cooling housing market in 2022, U.S. home prices are still hitting record highs, even with mortgage rates surging in recent months. WSJ’s Dion Rabouin explains what’s driving demand, evidence of a slowdown on the horizon, and what that could mean for the economy. Photo composite: Ryan Trefes

Hopes in the U.S. that further rent increases can offset cost growth look optimistic. True, vacancy rates in professionally managed rented accommodation are low at about 5%, giving landlords pricing power. And homeownership is increasingly unaffordable, which will drive demand to rent. The average fixed-rate 30-year mortgage has reached 5.78%.

Even so, growth in rents will likely slow. Real-estate research firm Green Street estimates that they will rise just 3% in 2023 as affordability becomes stretched. There is also a lot of new supply on the way. In 2021, construction began on 1.1 million single-family housing units in the U.S., the first time in 13 years that more than one million new builds have been in the pipeline. Construction of apartment complexes is at a 30-year high.

Some of the unusually high demand from tenants may prove to be a temporary trend linked to the pandemic. Net new leases for professionally managed flats increased by 713,000 units in the first quarter of 2022 compared with the same period of 2021, according to the Harvard report—more than double the average number in the five years leading up to the outbreak of Covid-19. Deferrals on student debt payments, government stimulus checks and wage growth all boosted young people’s finances, helping them to set up new households. This could unwind if tighter monetary policy sends the U.S. economy toward recession.

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Stock investors are already much more cautious about housing than private buyers. Shares in U.S. residential real-estate investment trusts currently trade at a 22% discount to gross asset value, according to Green Street—a good proxy for where investors think the value of the underlying real estate is headed. European shares imply a 26% fall in property values.

As interest rates go up, property owners are becoming more dependent on growth in rents to deliver decent investment returns on their expensive purchases. But there’s only so much that squeezed tenants can afford to pay. Landlords may soon find homes less comfortable.

Write to Carol Ryan at [email protected]

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