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There is a clear need for an increase in affordable housing, including single-family and multi-family units in both urban and suburban areas. For the past 15 years, the prices of homes in major cities in advanced economies have grown faster than incomes. This has made owning a home unaffordable for a growing number of households.
A look at the past five years of city-level data show that house prices have been growing at almost twice the rate of incomes (Exhibit 1). The high costs of homes have led to a decline in home ownership. That, in turn, has caused an increase in demand for rental housing; but rising rents, too, have stretched household budgets.1
This demand creates an opportunity to invest not only in the development of market-rate housing that could help alleviate shortages but also in dedicated affordable housing and conversions that would be developed in coordination with local governments.
Investments in residential properties are needed to meet the challenges, but before considering that, it is worth taking a closer look at the problem and its root causes.
House prices have risen much faster than household incomes
Two reasons new home construction hasn’t kept pace with demand
While the pandemic is far from over, and concerns about higher inflation and rising market interest rates persist, the backdrop for real estate markets in 2022 is one of transition to a new phase of recovery and expansion. Leading indicators are pointing upward, and even though the gap between the best- and worst-performing parts of the market remains wide, most sectors and regions are set for improved investment performance in the year ahead.
That renewed optimism raises a new challenge for investors: deploying capital that has been raised. But city office, apartment and retail markets that suffered during the pandemic are starting to come back into favor, and capital is increasingly finding its way into higher-returning operational assets, wherein returns are linked to long-term trends such as digital transformation, aging populations, and environmental sustainability.
Even though fundamentals of the housing sector have improved, not enough new homes have been built to meet the rising demand. Globally, there are two reasons.
1. Decreased appetite for development. Decreased interest in the development of properties is a legacy of the global financial crisis (GFC). Realized losses across real estate portfolios during that period drove a risk-off mindset. In the private sector, investors shied away from developments and focused on assets with secure cash flows. The appetite to develop became further dampened by rising construction costs, tougher bank financing regulations and years of geopolitical uncertainty. And even as real estate transaction volume recovered, hitting a high in 2019 that matched pre-GFC levels, the share going into land acquisitions today remains 30% below levels seen before the financial crisis.2
For the residential sector in particular, the story is similar: the development pipeline improved slowly, but then only selectively. In the pre-COVID-19-pandemic years, private developers focused on delivering high-end, grade-A apartments in major cities. And at the same time, the public sector’s provision of housing also faced challenges. The GFC stretched government finances, and that limited the provision of social housing. In the United States, during the past decade, public-housing stock declined more than new regulated housing was being added.
Today, as urban jobs and population growth are recovering, supply bottlenecks, rising cost inflation and uncertainty caused by the Russia–Ukraine war are holding back new development.
2. Household finances hindered by weak wage growth. In the years following the GFC, many analysts expected that demand for housing would grow strongly, spurred by the economic recovery and, in the case of the United States, by changing demographics. Outside the United States, demand was being driven by rising household formation linked to smaller families and aging populations. Those circumstances suggested more people would have the incomes needed to purchase homes.
Those expectations didn’t play out. The economic recovery that followed the GFC was driven by jobs, not productivity gains. As a result, wage growth was historically weak, and against limited stock, house prices were driven up. That left many households unable to raise the finances necessary to buy. More people were forced to rent. In major U.S. cities, for instance, just before the pandemic struck, multifamily vacancy rates hit 20-year lows.3
Emerging trends to add to the need for rental housing
In the years ahead, the major drivers of the current conditions are likely to remain in place. Global economic growth is set to trend lower, largely because of aging populations; and the weaker productivity growth that stems from aging workforces is likely to keep wage growth low. The pressures that have made homes unaffordable for many households will persist. There are some nuanced changes in the narrative, however.
- Younger generations in particular want more mobility. They are delaying getting married and having children, which gives them the freedom to easily move. And that desire for a flexible lifestyle leads to renting over buying.
- People, especially those with families, want more living space. That has created an exodus from urban areas. And the rise in remote working has accelerated that trend, now that fewer people have to factor commuting time into their decisions about where to live.
- Government budgets are strained. Few governments today have the resources needed to increase the availability of affordable public housing.
These trends only exacerbate tougher economic conditions that today’s households face — higher inflation, higher taxation and higher interest rates — thereby making housing even more unaffordable for many.
The case for increased investment in the residential sector
Residential investment has been a significant part of the investment landscape since the 1980s in the United States, Germany, the Netherlands and Japan.4 In other countries, it’s a trend that continues to emerge. Residential transaction volume as a share of all investment activity has doubled globally in the past 10 years, from 10% to 20%.5 That share will continue to grow over the coming years.
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- See, for instance, “Making Affordable Rental Housing Part of Europe’s Recovery,” IMF Global Housing Watch, May 2021.
- Source: Real Capital Analytics, March 2022.
- Source: NCREIF, March 2022.
- Apartments were added as a property type to the NCREIF Property Index in 1984.
- Source: Real Capital Analytics, March 2022.
