Article | Evolving Workforces
Higher mortgage costs are driving demand towards the rental market in Europe
June 20, 2024 10 Minute Read
Executive Summary
The demand for rental properties across Europe is increasing due to higher mortgage rates, making home ownership less affordable. This trend is expected to continue despite a slight projected decrease in mortgage rates. Despite renting being relatively cheaper, it is clear that more and more countries are discussing, or have already implemented, regulation in the rental market. In practice, however, it appears that with more regulation, the demand for rental housing increases, while the supply tends to decline. As a result, the gap between buying and renting is widening, slowing the transition of households from rental to owner-occupied housing.
Ultimately, it remains critical to ensure the construction of new homes is less volatile. Currently, new developments are too cyclically sensitive, resulting in a severe housing shortage in most European cities. In our view, the main solution is an anti-cyclical policy, in which governments can offer more leeway to developers and investors during economic headwinds. On the other hand, it is precisely in times of economic strength that governments can be stricter in their planning requirements. This creates more flexibility on the cost side of housing construction, allowing cyclical fluctuations to be better absorbed and enough housing stock to be added every year, which is ultimately the solution to counteract any sharp increase in housing costs, both for buying and renting.
The demand for rental properties across Europe is increasing due to higher mortgage rates, making home ownership less affordable. This trend is expected to continue despite a slight projected decrease in mortgage rates. Despite renting being relatively cheaper, it is clear that more and more countries are discussing, or have already implemented, regulation in the rental market. In practice, however, it appears that with more regulation, the demand for rental housing increases, while the supply tends to decline. As a result, the gap between buying and renting is widening, slowing the transition of households from rental to owner-occupied housing.
Ultimately, it remains critical to ensure the construction of new homes is less volatile. Currently, new developments are too cyclically sensitive, resulting in a severe housing shortage in most European cities. In our view, the main solution is an anti-cyclical policy, in which governments can offer more leeway to developers and investors during economic headwinds. On the other hand, it is precisely in times of economic strength that governments can be stricter in their planning requirements. This creates more flexibility on the cost side of housing construction, allowing cyclical fluctuations to be better absorbed and enough housing stock to be added every year, which is ultimately the solution to counteract any sharp increase in housing costs, both for buying and renting.
Over the past two years, the affordability of an owner-occupied home in Europe has deteriorated significantly. Sharp increases in mortgage interest rates have caused the average monthly gross mortgage expense for a new home in Europe to rise to €2,015 per month in 2023. Despite an expected slight decline in mortgage interest rates, these costs are not expected to decrease in the future. In almost all cities in Europe there is a severe housing shortage, indicating that house prices will continue to rise by an average of 2.7% per year.
The relative rise in the cost of buying a home is shifting demand towards the rental sector across Europe. The rental sector already saw an increase in structural demand – partly due to the need for housing flexibility – but demand is now also increasingly driven by economic factors. Renting is now cheaper than buying in most European cities due to rising mortgage rates over the last two years. This does not necessarily mean that households in owner-occupied housing are now switching to the rental market, but rather that tenants are now staying longer in their rental homes. This trend ultimately increases the structural demand for rental housing, but it also marks a decline in the transition from the rental market into the owner-occupational market.
Figure 1: Average monthly multifamily rent vs new home gross mortgage payment
Source: CBRE, Bank of England, Danmarks Nationalbank, De Nederlandse Bank and Statistics Sweden
Given the severe lack of available rental housing, this has a clear shift and price effect. Demand for student housing, various types of co-living and serviced apartments is also increasing, mainly due the fact that there is insufficient BTR multifamily stock to meet demand. Therefore, the structurally increased demand, combined with inelastic supply, is causing higher rents in the rental housing market. Over the next three years, we expect annualised market rental growth of 3.9%, which is comparable with the last seven years’ average growth rate of 4.1% per annum.
Figure 1: Average monthly multifamily rent vs new home gross mortgage payment
Source: CBRE, Bank of England, Danmarks Nationalbank, De Nederlandse Bank and Statistics Sweden
Given the severe lack of available rental housing, this has a clear shift and price effect. Demand for student housing, various types of co-living and serviced apartments is also increasing, mainly due the fact that there is insufficient BTR multifamily stock to meet demand. Therefore, the structurally increased demand, combined with inelastic supply, is causing higher rents in the rental housing market. Over the next three years, we expect annualised market rental growth of 3.9%, which is comparable with the last seven years’ average growth rate of 4.1% per annum.
Affordability discussion is too focused solely on the rental housing market
Interestingly, higher rental growth – which is merely a result of market forces – tends to lead to tense discussions regarding affordability. Yet, remarkably, the rental housing market in many cities is still considerably more affordable than the owner-occupied housing market in those same cities. Only in Milan, the cost of a condo is still virtually comparable to the cost of renting. In other cities, we see a deterioration in the affordability of owner-occupied housing relative to renting.The relative pricing of rental housing has improved over the years compared to owner-occupied housing. This is of course largely due to increased mortgage interest rates, however, it is also because, on average, owner-occupied home prices have increased more than rental prices in most cities.
Figure 2: Cost multiplier of new home mortgage payment vs monthly multifamily rent
Source: CBRE, Bank of England, Danmarks Nationalbank, De Nederlandse Bank and Statistics Sweden
Yet when such measures are introduced, too little attention seems to be paid to the side effects. We are already seeing a decline in the available supply of rental properties in both Catalonia and the Netherlands. Investors are withdrawing from the residential investment market, while regulation is further increasing the demand for this type of housing. In short, supply-demand ratios continue to deteriorate.
In addition to this, the financial gap between renting and buying is widening. This is especially evident in Stockholm, which is one of the most regulated rental markets in Europe. The vacant possession value is uninhibited by regulation, causing a large gap between the cost of renting and buying a home in Stockholm. This regulation not only strongly influences demand in the rental market, but it also hinders the flow to the owner-occupied market, and ultimately, further increases the demand for rental housing.
In short, regulation can contribute in the short-term to improving the affordability of the existing rental market. In the long-term, however, it leads to a reduction in investment in the rental housing market, a crucial factor in increasing supply and restoring balance in the market. In addition, regulation negatively impacts the functioning of the housing market and can exacerbate wealth inequality in the long-term.
Source: CBRE, Bank of England, Danmarks Nationalbank, De Nederlandse Bank and Statistics Sweden
Side effects of regulation are often greater than actual affordability impact
At the same time, initiatives for increased regulation of the rental housing market are emerging in many countries and regions with the goal of keeping the sector more affordable. Catalonia, for example, has introduced the new Rental Price Reference Index, and the Dutch Government agreed in late April to regulate rents for a large proportion of smaller housing units in the Netherlands.Yet when such measures are introduced, too little attention seems to be paid to the side effects. We are already seeing a decline in the available supply of rental properties in both Catalonia and the Netherlands. Investors are withdrawing from the residential investment market, while regulation is further increasing the demand for this type of housing. In short, supply-demand ratios continue to deteriorate.
In addition to this, the financial gap between renting and buying is widening. This is especially evident in Stockholm, which is one of the most regulated rental markets in Europe. The vacant possession value is uninhibited by regulation, causing a large gap between the cost of renting and buying a home in Stockholm. This regulation not only strongly influences demand in the rental market, but it also hinders the flow to the owner-occupied market, and ultimately, further increases the demand for rental housing.
In short, regulation can contribute in the short-term to improving the affordability of the existing rental market. In the long-term, however, it leads to a reduction in investment in the rental housing market, a crucial factor in increasing supply and restoring balance in the market. In addition, regulation negatively impacts the functioning of the housing market and can exacerbate wealth inequality in the long-term.
The financial gap between renting and buying, particularly in Stockholm's highly regulated market, is significantly widening due to uninhibited vacant possession value
Countercyclical housing programming policy can help reverse trend in permit level
Instead of imposing additional regulation, the key solution is to increase the appeal of the construction of all segments of rental housing. Currently, the increased cost of capital in many European cities makes a new construction business case less viable, so flexibility and strategic planning are crucial to prevent a sharp decline in the construction of new rental housing.Figure 3: Index permit level of new home construction in the European Union and Great Britain
Source: Eurostat, Glenigan (based on moving average total)
A countercyclical policy can help reverse the sharp decline in permit levels (EU:-32% / GB:-28% in two years’ time), avoiding the need to wait for construction costs to return at a level at which new development is financially viable. Such policies could include stricter enforcement of construction, programming, and volume conditions during periods of economic prosperity, and more lenient applicating in times of economic downturn.
At the time of the GFC – when housing market permit levels in Europe also fell sharply – several countries opted to either increase generic lending capacity or specifically increase lending capacity for first-time buyers. Such measures could be effective when there is insufficient market demand, which is not currently the case. At the same time, in some countries – including the Netherlands – we saw a willingness to shift the building programme from buying to renting, and modifying housing products to more small-scale living spaces, because these modifications sold better at the time and thus brought a better result for the developer. This flexibility seems to be much less apparent now, even though it could greatly reduce the decline in construction activity.
By implementing these measures, you can create more cost flexibility and better returns for construction projects, making it easier for project developers to respond to economic downturns. Overall, these policies should lead to a less volatile housing pipeline in Europe and contribute to resolving the core issue of supply shortage.
A countercyclical policy can help reverse the sharp decline in permit levels (EU:-32% / GB:-28% in two years’ time), avoiding the need to wait for construction costs to return at a level at which new development is financially viable. Such policies could include stricter enforcement of construction, programming, and volume conditions during periods of economic prosperity, and more lenient applicating in times of economic downturn.
At the time of the GFC – when housing market permit levels in Europe also fell sharply – several countries opted to either increase generic lending capacity or specifically increase lending capacity for first-time buyers. Such measures could be effective when there is insufficient market demand, which is not currently the case. At the same time, in some countries – including the Netherlands – we saw a willingness to shift the building programme from buying to renting, and modifying housing products to more small-scale living spaces, because these modifications sold better at the time and thus brought a better result for the developer. This flexibility seems to be much less apparent now, even though it could greatly reduce the decline in construction activity.
By implementing these measures, you can create more cost flexibility and better returns for construction projects, making it easier for project developers to respond to economic downturns. Overall, these policies should lead to a less volatile housing pipeline in Europe and contribute to resolving the core issue of supply shortage.
