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One year post-intervention: Exit of foreign, short-term investors and less than expected drop in prices

residential market intervention section 5(2

The residential market intervention aimed at section 5(2) of the Danish Housing Regulation Act has clearly taken its toll in terms of lower prices, a slowdown in activity and a narrower field of buyers, today almost exclusively counting investors with a long-term investment horizon. 

Flashback to 2019. Media headlines are unequivocal: They read that seemingly greedy foreign investors are taking over old-stock residential properties to subsequently raise the rent payable by new tenants to exorbitant levels as soon as the properties have been modernised.

The old residential building stock offers particularly attractive investment opportunities: Properties often enjoy a good location in major Danish cities, and as many are also comprised by the rules of cost-regulated rent control, so-called cost-regulated properties, the segment is associated with exceptionally low vacancy risk.

Pursuant to section 5(2) of the Housing Regulation Act, it is possible to raise the rent of such properties to match utility value, provided residential units are comprehensively modernised as they become vacant. As a result, investments in old-stock residential properties also offer lucrative excess returns. This has truly whetted the appetite for this property type among foreign private equity funds in particular, fronted by Blackstone.

 residential market intervention section 5(2)

The 2019 headlines soon reached the Danish Parliament, Christiansborg, creating a political stir due to a massive acquisition spree based on business plans targeting quick modernisation of rental units for the purpose of raising rents.

The unrest fed through to the investment market in terms of uncertainty and a wait-and-see attitude in the investor community. In January 2020, a political majority therefore agreed to amend section 5(2) of the Housing Regulation Act, effective as from July 2020.

How amendments have affected the market
Although the political agreement helped to clarify the new rules, there were diverging views as to its long-term effect on both investor composition, prices, and transparency in the market.

It is only now that we are starting to garner the first post-intervention experiences.

Pricing
Capital abundance and demand: In the past 12 months, the property market in general, including the market for residential properties subject to cost-regulated rent control, has experienced massive demand due to substantial capital placement requirements in the wake of a dramatic drop in interest rates along with large amounts of capital being injected into the market in response to the coronacrisis.

Seen in isolation, the resulting improvement of the market is estimated to have driven up prices by 2-4% in the period from the effective date of the amended legislation to date, due to yield compression. 

Drop in prices of cost-regulated properties: Judging by a review and analysis of realised transactions involving properties subject to cost-regulated rent control, prices have dropped by 5-10%.

A downward correction of old-stock residential property prices was anticipated, in particular on properties with a large share of rental units not yet modernised and therefore covered by the rules of cost-regulated rent control. Nevertheless, the realised sales indicate a less than originally expected drop in prices, all other things being equal, which is also to be held up against the market recovery.

Investor composition 
Shift towards long-term investments: We have seen a shift from long-term investors with high yield requirements, mainly property funds, towards long-term investors whose pricing practices are less affected by the implications of the qualifying period. Whereas the investment strategy of short-term investors typically used to involve an aggressive business plan targeting quick modernisation of properties to achieve higher returns, there is now a sharper focus on a longer holding period to achieve additional returns.

Finding it difficult to reconcile a longer investment horizon with their current business plans, short-term investors driven mainly by high yield requirements are zooming in on other segments.

Fewer foreign investors: Whereas 2018 saw a predominance of foreign investors in this segment, the period following the intervention has seen a shift almost exclusively in favour of domestic investors.

One of the main explanations may be that many investors used to be foreign private equity funds with a short-term investment horizon, and as they exit the market, the number of foreign investors drops accordingly. In addition, the political instability in an already complex and regulated market may in the short term have contributed to deterring foreign investors.

Transaction activity
Transaction activity is starting to brisk up, rebounding from a slump in 2019 when uncertainty was mounting. Although the key elements of the intervention have been clarified, we are still left with prospects of very few sales, many of them involving cooperative housing properties, which are not subject to a qualifying period.

This may indicate that the market is yet to reach some kind of broad consensus on the issue of the discrepancy in buyside and sellside price expectations – a discrepancy arising due to the implications of the qualifying period. Nevertheless, we see an increasing normalisation process in the market as the unrest has subsided and investment activity picked up.

Institutional investors and property companies taking the lead: In the past, property funds were aggressive on pricing, and as they have exited the market, they have made room for investors pursuing a longer investment horizon and lower yield requirements, mainly institutional investors and property companies.

Long-term investors are generally more open to discussing how to bridge the gap between their own price expectations and those of the sellside.

This negotiation preparedness mainly ties in with the long investment horizon on the buyside, with the buyer able to spread possible losses over multiple years. Furthermore, the properties are rarely earmarked for re-sale in the span of few years. All other things being equal, the shift in investor composition has had a small, but favourable effect on investment activity.

residential market intervention section 5(2)

residential market intervention section 5(2)

 

Pipeline of new transactions despite intervention
Despite the relatively sluggish post-intervention investment market, we expect investment activity to pick up soon in the segment. The old residential stock continues to offer attractive low-risk investment opportunities and the possibility of achieving higher returns via proactive asset management.

In a market characterised by uptrending prices on alternative low-risk property investments as well as massive capital placement requirements, we fundamentally expect to see an increase in transaction volume.

"Despite the relatively sluggish post-intervention investment market, we expect investment activity to pick up soon in the segment.

Not only does the segment experience mounting demand, but supply is also set to increase when uncertainty in the sellside community subsides even further, and investors pursuing a divestment strategy learn that more long-term investors are prepared to pay fair prices.

This may be another factor that helps to compensate for the gap between buyside and sellside pricing due to the qualifying period.

In any event, the gap likely narrows as an increasing number of cost-regulated rental units are modernised over time. By the same token, investors looking to reallocate are likely to modernise as many units as possible prior to divestment to best align the price expectations of the parties.

Nonetheless, we believe that old-stock residential properties in the short term will be susceptible to a market downturn as a downward adjustment of prices, all other things being equal, will expose the discrepancy between buyside and sellside pricing, potentially putting transactions on hold.

In addition, the uncertainty in terms of possible future regulations in an area where politicians have proved willing to make legislative amendments may well serve to keep investors on the sideline, although in our opinion with only short-lived effect. 

Short-term investors will remain passive in the segment, and those active will mainly be long-term investors with lower yield requirements, e.g. institutional investors.

We expect foreign investors to return to the segment but to increasingly join forces with domestic asset managers to make the right decisions in the market. 

residential market intervention section 5(2)

 

 

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