Impact analysis of mid-rent regulations

On 9 December, Minister of Housing Hugo de Jonge briefed the House of Representatives on the final version of the new rent regulations for the mid-rent segment. Using so-called ‘collision tests’ and other methods, Minister De Jonge has spent the past 10 months trying to find the right balance between tenant protection, sufficient availability of affordable housing, willingness to invest among landlords and encouraging sustainability. To ensure this balance, he has created a general outline that will likely be translated into legislative proposals in early 2023. This would lead to the establishment of a regulated mid-rent segment in the Dutch housing market by 1 January 2024.

Compared to the parliamentary letter of 14 October 2022 – on which we based our earlier publication – a number of outlines have been added and clarified, calling for a reassessment of our previous forecast. Before going into the results of our new calculations, we will first discuss all relevant outlines.

Outlines of mid-rent regulations bill:

• Regulations will only apply to new leases
• Regulations will apply to homes up until 187 WWS points (based on housing valuation system)
• Regulations will be temporary (they will be in effect as long as there is scarcity, indicators yet to be specified)
• Annual rent increase will be linked to the collective labour agreement wage increase + 0.5% (instead of to the CPI)
• Housing valuation system will become mandatory rather than enforceable
• Allocation of housing based on current provisions under the Housing Act
• Previous agreements between municipalities, developers and investors will be taken into account during the consultation period ahead of the bills’ introduction
• Transitional phase: temporary price surcharge for new-built homes completed after 1 January 2024 with start of construction before 1 January 2025. Total price surcharge of 5% for 10 years on top of maximum allowable rent
• Housing valuation system to be modernised:
  
  • Homes with energy label A or higher get more points (+4 to +10 points)
  • Homes with energy label E or lower get fewer points (-6 to -10 points)
  • Extra points for outdoor space (2 to 9 points for outdoor space smaller than 25 sq. m., proportional to size)
  • Maximisation (33%) of WOZ value above 187 points

Impact on number of regulated homes

In comparison to our previous calculations, we see a limited shift, with a larger proportion of housing remaining in the unregulated sector. This slight shift can mainly be attributed to the fact that the negative effect of point deductions for unsustainable homes does not outweigh the positive effect of the extra points that will be given to sustainable homes or homes with outdoor space up to 25 sq. m.

Our latest calculations show a net reduction of 3,000 homes – after re-letting – in the regulated sector compared to our calculations based on the outlines published in October. This amounts to 0.5% of the total current unregulated rental housing stock. In our latest calculations, we assume that around 327,500 homes (4.1% of the total housing stock in the Netherlands) will fall into the new regulated mid-rent segment.

Rent reduction increased

If homes – after re-letting – revert to the regulated sector, this will have a significant impact on maximum rents. However, relative to our initial calculations, the rent differential between A++ label homes and F label homes has increased significantly. The fact that sustainable homes will now receive more points while unsustainable homes will be subject to point deductions is set to have significant implications for the average rent reduction.

Figure 1: Rent reduction per energy label (for a 60 sq. m. home)

In the initial calculation, the average rent reduction was 26%. This percentage has dropped to 22% due to the extra points for sustainable homes. The opposite is true for homes with poor sustainability scores. For instance, rent for an F label 60 sq. m. home will drop by an average of 48% in the 20 largest cities. Previously, this was 45%.

All in all, this ensures that a larger number of unsustainable homes will be regulated, which means the rent reductions will also be more significant. On the other hand, the number of sustainable homes in the regulated segment will decrease, and those that do revert to the regulated sector will now see more limited rent reductions than previously calculated. In addition, the change in the housing valuation system has implications for both the construction of new housing and investors’ prospects.

Slight positive impact on new construction, but consequences for meeting specific housing demand

The points increase for sustainable homes has positive implications for new construction. The higher number of points will make it slightly easier to realise new construction within the unregulated sector. Still, the required usable area remains relatively high compared to the current plans of many municipalities. Across the 20 largest municipalities, the average bottom limit for usable area is 64 sq. m., excluding so-called ‘traffic spaces’, such as corridors.

This adjustment in the housing valuation system will make it easier to build new homes in the unregulated sector again. However, this also means that many existing plans now require serious adjustments – adjustments that will be time-consuming and that may come at the expense of meeting the market’s demand for specific types of housing. Partly as a result of the individualisation of society (in ten years’ time, almost half of all households will be single-person), there is a strong need for good-quality housing in the 50 to 70 sq. m. range. But with the current adjustments, there will be less construction for this segment due to a stronger focus on larger homes – homes that do not match market demand.

Figure 2: Bottom limit (usable area) for new-build homes to be constructed in the unregulated sector¹

The bottom limit does vary by municipality, largely due to geographical differences in home values. For example, the bottom limit for usable area is 47 sq. m. on average in Amsterdam and 74 sq. m. in Enschede. It should be mentioned that the bottom limit is highly project specific, as the final WOZ value is determined by the project’s exact location. For the sake of convenience, this analysis is therefore based on average figures.

All in all, the new regulations will provide scope for more new construction. However, we do expect property developers to seek cooperation with housing corporations more often in order to be able to realise mid-rent housing. The extent to which institutional investors will also re-enter this segment depends on whether they will be able to compete on a level playing field with housing corporations. So far, this does not seem to be the case, making it unlikely that institutional investors will assume a major role in the new regulated mid-rent segment. Moreover, many institutional investors suffered substantial losses in 2022, causing them to scale back their real estate investments.

Optimising WWS score and selling to tenants

Despite the fact that the outlines now paint a more complete picture of future rent regulations, the risk remains that adjustments will be made to the current proposals before they become law. And despite the fact that the current outlines do provide some measure of certainty, investors are nevertheless exploring their options. Perhaps the most obvious course of action would be to optimise properties’ WWS scores, ensuring that they stay unregulated after the introduction of the new regulations.

Our calculations show that 16% of future regulated mid-rent homes are within 10 points of the new rent control limit, which means that point optimisation would be a viable option for at least one in six homes (a total of approximately 55,000 homes). This share is likely even higher given the large number of points that can be earned by making properties more sustainable. However, there are a number of critical observations to be made here that show that encouraging sustainability is not always profitable or financially feasible.

For many investors, investing in sustainability only becomes worthwhile when it also leads to a score that exceeds the rent control limit. For many smaller homes (65 sq. m. or smaller) – including walk-up homes – sustainability investments will not necessarily lead to a score above the rent control limit. As a result, owners of these properties will have no incentive to make these kinds of investments. Moreover, investing in the sustainability of properties that fall under a homeowners’ association (VVE) structure can be complex. While Minister De Jonge is considering simplifying the decision-making process of VVEs, the fragmented ownership of such properties can make it more difficult to invest in sustainability in the short run.

Moreover, these properties are mostly owned by private investors who will also reconsider their investment strategy in light of the Box 3 tax changes. Thanks to the combined effect of these tax adjustments and the new rent regulations, many private investors will opt to sell properties to their tenants, without making sustainability investments. In addition, due to the changed loan-to-value or interest coverage ratio, private investors who purchased their properties using loans may also be forced to sell – making it less likely that they will invest in sustainability.

Right balance has not been found

When looking at the overall effect of these rent regulations, the right balance between tenant protection, sufficient availability of affordable housing, willingness to invest among landlords and encouraging sustainability has arguably not been found.

Indeed, while investment appetite will benefit from these latest adjustments, the regulations will lead to a sharp deterioration compared to the previous situation. This is already causing investor withdrawals from the Dutch market, even though investors are badly needed to build sufficient new sustainable rental homes in the Netherlands. On top of that, as stated in our earlier report, these rent regulations will not add enough affordable housing. Some rental properties that are currently unregulated will become more affordable with these regulations, but, as stated earlier in this publication, many of these homes will be sold to tenants, receding into the owner-occupied market (55,000 to 105,000 homes). Also, a significant proportion of homes will be renovated (made more sustainable and luxurious) so they exceed the rent control limit. Finally, the question is whether there will be enough mutations to ensure that affordable rents are actually realised, as supply is very limited. On balance, this means that the number of homes in the new regulated segment will be significantly lower than expected.

Although the new regulations will catalyse sustainability investments, the effect will be somewhat limited, as these kinds of investments will usually become profitable only when they lift the property in question out of the regulated segment. This is not the case for many smaller, older homes, leaving them within the newly formed regulated sector, rendering sustainability investments unprofitable.

Finally, the combined effects of the new regulations will not lead to better tenant protection. Given the fact that the number of rental properties will soon actually decrease – rather than increase as in recent years – there will be less available stock in both the new regulated mid-rent sector and the new unregulated sector. This will lead to waiting lists in the regulated sector and stronger market rent increases in the new unregulated sector.