The Market Seen from the Street: "Why there is no rental market in Portugal?"
There are several perspectives and opinions, some more logical than others, when it comes to justifying the lack of a residential rental market in Portugal. This is a sensitive subject that deserves serious consideration so that we can find efective solutions that allow for the development of this "asset class".
The Portuguese Government has a fundamental role in creating conditions to change the reality of the residential rental market in Portugal. There are estimates that point to the precarious living conditions of around 60,000 to 80,000 families in te country. In the short term, it is necessary to allocate the necessary efforts to reply to the problem, analyzing the State's Vacant Property, assessing the need for renovation/rehabilitation of the same in order to improve the habitability conditions of the families that need it most. Affordable Rent programs, Social Housing, and Controlled Costs Houses that have been created, didn´t worked.
On the other hand, it is necessary to have a medium/long-term purpose that allows for the creation of a sustainable and dynamic residential rental market. We will only be able to develop this market if we have a plan with "head, trunk, and limbs" to attract investment. Attracting investment depends on two fundamental assumptions: Profitability & Stability.
The Government, individually, does not seem to have the conditions to invest in solving the problem.
At the European level, statistics show that about 70% of the population lives in their own house. Only 30% of the European population “apply” to the rental market. In Portugal, the ratio exceeds the European average. About 78% of the population lives in their own house. (https://ec.europa.eu/eurostat/web/products-eurostat-news/-/wdn-20211230-1).
According to a study ("The Real Estate Market in Portugal") developed by the Francisco Manuel dos Santos Foundation, "of the percentage of families that had more than one home in 2017 (29.2% of the total), only 13.4% rented any additional housing (while in the euro area this value was 41.4%)". But then, what are the reasons for this fact?
"The law protects the tenant too much and puts too many risks on the landlord."
"The taxes on rental income are too high."
"In Portugal, there is a culture of ownership, about 78% of population live in their own home. Buy their own house it´s the preference”.
"It is cheaper to buy a home than to rent."
"It is not an attractive market from an investment perspective."
"In case of non-compliance by the tenant, the landlord has great difficulty in applying the right to evict."
"Building for rent is not economically viable."
"There is not enough supply."
"The Rental Market in Portugal does not work due to legislative instability in matters related to urban leases."
"The blame lies with local accommodation."
"The Golden Visa is the “great” responsable.”
"Easy access to mortgage credit keeps people away from renting."
"Building to sell is more profitable."
All of the "justifications" presented may have their reasons.
However, in the last years we have observed a profound transformation in the dynamics of society in general which, in my opinion, creates a need to develop the rental market and at the same time an excellent opportunity.
The average household size decreased from 3.7 person in 1960 to 2.5 person in 2021. (https://www.pordata.pt/portugal/dimensao+media+das+familias+segundo+os+censos-908)
The number of divorces per 100 marriages increased exponentially from 1% in 1960 to 59.5% in 2021. (https://www.pordata.pt/portugal/numero+de+divorcios+por+100+casamentos-531)
The number of single-parent households grew from 203,654 households in 1992 to 429,968 in 2022, more than doubling. (https://www.pordata.pt/portugal/agregados+domesticos+privados+monoparentais+total+e+por+sexo-20)
New work dynamics with the institution of remote work for several activities that previously required physical presence in the workplace created completely different mobility needs from what we were used to. (https://eco.sapo.pt/2022/08/16/mais-de-um-milhao-de-pessoas-em-teletrabalho-so-30-devido-a-covid/)
Portugal is an increasingly global nation that receives more and more citizens from other geographies who choose our country to study, work, and live for a certain period of time (or permanently), which means we have even more pressure on the housing market.
The way citizens are paid for their professional activities has been evolving from a model of "Fixed Remuneration + a small variable remuneration" to "Variable Remuneration + small fixed remuneration", which brings challenges regarding how banks "treat" the housing credit product.
The "mobility" of society is increasing, and buying a house for permanent residence may be an investment with less sense.
In summary, if we can develop products adapted to people's needs with affordable rents, I have serious doubts that the Occupancy Rate will be less than 100%. I don't have a miraculous idea that brings obvious solutions, but I am convinced that if we plan properly at the level of Territory Management, Transport Network, Fiscal Stability, and Urban Planning, we will create conditions for a functional, sustainable, and dynamic rental market. Interestingly, in April, Idealista developed and published the result of a study that demonstrates, in a simple and expeditious way, the gross profitability of buying a house in Portugal to put it on the rental market. (https://www.diarioimobiliario.pt/Comprar-casa-e-coloca-la-a-arrendar-rendeu-6-6-no-primeiro-trimestre)
District Capital Renting Price per sqm Selling Price per Sqm Housing Yield
Santarém 6 945 7,6%
Viana do Castelo 8,3 1391 7,2%
Leiria 6,5 1302 6,0%
Coimbra 8,1 1656 5,9%
Braga 7,1 1525 5,6%
Funchal 11 2552 5,2%
Setúbal 8,9 2090 5,1%
Viseu 5,4 1277 5,1%
Porto 12,3 3133 4,7%
Faro 9,3 2493 4,5%
Aveiro 8,7 2423 4,3%
Lisboa 15,7 5002 3,8%
The formula used in the calculation is one of the simplest in the real estate market, while still being a good "barometer" to gauge balances or imbalances that may exist between the variables involved.
Y (Yield)= R (Annal Rent) / V (Property Value)
The data presented in the table above demonstrates the differences between locations, which are explained by the greater or lesser liquidity of each market and its level of risk. This means that, theoretically, Lisbon has more buyers willing to accept a lower yield because they prefer less risk. For this reason, the yield in Lisbon is lower than in the other cities mentioned.
We should not forget that there are several other costs to deduct from the rent received in a residential lease transaction before reaching the net income. I would like to highlight the following Operating Costs:
Management Costs;
Vacancy Costs;
Maintenance Costs;
Financing Costs;
“Uncollectibles”;
Other Costs;
In summary, about 20% of the rent received relates to "Operating Costs".
Gross Yield - Operating Cost = Net Yield Before Taxes
Note that income taxes will still be imposed on this result.
Based on this Gross Yield premise, I decided to create an exercise that would allow me to obtain some results regarding possible changes in the development assumptions (with special emphasis on Number of Units, Size per Typology, and Construction VAT).
Small details can make a big difference in the feasibility of Real Estate Development Projects.
To make some results more explicit, I will use the assumptions I created for the last published reflection (https://andrecasaca.pt/artigos/o-mercado-visto-da-rua-quanto-custa-fazer-um-casa), which I will call "Program 1".
“Program 1” Assumptions:
Type of Development: New Construction, VAT 23%
Location: Urban High-Density Area
Land Area: 24,000 sqm
Above-Ground Gross Construction Area: 16,800 sqm
Below-Ground Gross Construction Area: 5600 sqm
Balcony and Terrace Area: 2632 sqm
Common Areas (Staircases/Circulation Areas and Elevators): 3640 sqm
Number of Above-Ground Floors: 6
Number of Below-Ground Floors: 2
Number of Apartments: 175
Number of Parking Spaces: 205
We must not forget that all the assumptions presented result from urban planning rules. I also reiterate that we are not defining any specific location.
Tipology Number of Units Parking Places Gross private Area Terraces & Balconies Area
T0 30 30 37 7
T1 25 25 56 11
T2 90 90 80 16
T3 30 60 115 23
Total 175 205 288 57
Acquisition/Land Costs: We leave this cost at 0, as it will depend on the value of the land in a specific location that we may choose.
Acquisition Costs
Taxes
Technical and Legal Due Diligence
Project Costs, including VAT: 593,803.00€
Preliminary Studies
Licensing Projects (Architecture and Engineering)
Execution Projects (Architecture and Engineering)
Energy Certification
Acoustic Certification
Other Certifications
Municipal Fees: 1,737,513.54€
TRIU (Fee for the Realization, Maintenance, and Reinforcement of Urban Infrastructure)
Occupations of Public Streets
Fees for Submission of "Projects and Applications"
IMI (Municipal Property Tax) and AIMI (Additional Municipal Property Tax)
Construction Costs, including VAT: 21,756,769.98€
Civil Construction and Materials Contracts
Infrastructure (Water, Electricity, Sanitation, Gas, Telecommunications Connections)
Works Supervision
Insurance
Impredictables
Policing/Security
Project Management and Administration Costs, Including Taxes: 1,011,850.39€
Operating/Structure Costs
Outsourcing Costs
Financing Costs: 1,924,328.497€
Processing Fees
Stamp Duty on Capital Used
Interest
Marketing and Sales Costs: To simplify, we will leave this cost at 0, as we did with the land.
Marketing Materials
Real Estate Brokerage
In summary, developing a residential project with 175 houses (with balconies) and 205 parking spaces can cost approximately 27,024,265.41€, excluding the land value, promotion profit margin/remuneration of invested capital, and marketing and sales costs.
Translating this number into an average cost per Typology, we have:
Tipology Number of Units Average Cost per Unit
T0 30 75 980,08 €
T1 25 114 996,87 €
T2 90 164 281,25 €
T3 30 236 154,30 €
Total 175 27 024 265,41 €
Taking into account the production cost of the typologies described in "Program 1", assuming a yield of 6%, we arrive at a unitary renting price of 9.63€/sqm which seems quite reasonable to me.
Tipology Number of units Average Cost per Tipology Yield Monthly Rent (sqm) Unitary Rent per sqm
T0 30 75 980,08 € 6% 380 9,63
T1 25 114 996,87 € 6% 575 9,63
T2 90 164 281,25 € 6% 821 9,63
T3 30 236 154,30 € 6% 1181 9,63
Total 175 27 024 265,41 € 135 121,33 €
Analyzing the table above, the T2 and T3 typologies already reach rental values slightly above the possibilities of a "household" whose net monthly income does not exceed €2,000.
In this case, rents should not exceed €700/month ("Effort Rate <= 35%")
Therefore, my goal with the exercise I will present next is to decrease the rents per typology, only by changing architectural definitions of the "preconceived" product and reducing Construction VAT, from 23% to 6%.
Here are the assumptions for "Program 2":
Let's imagine a plot of land with 24,000 sqm , where it will be possible to build about 16,800 sqm above ground.
Type of Development: New Construction
Gross Construction Area Above Ground: 16,800 sqm
Gross Construction Area Below Ground: 2800 sqm
Area of Balconies and Terraces: 2688 sqm
Common Areas (Staircases/Circulation Areas, Elevators, and Common Laundry Area): 3640 sqm
Number of Floors Above Ground: 6
Number of Floors Below Ground: 1
Number of Apartments: 240
Number of Parking Spaces: 135 car spaces + 120 motorcycle spaces
Compared to "Program 1", there are "different rules in terms of parking spaces", we have incorporated a Common Laundry Area, but the major change lies in the "Mix of Typologies" and the VAT to be applied to the Construction Cost item.
The parking spaces are no longer allocated to specific apartments, they can be rented by the apartment users but can also be rented to the public in general. In any case, the Garage area should generate additional income for the asset.
The table below summarizes the Mix of Typologies of the Development. The number of units per Typology is highly debatable because it depends on the needs of each specific location. For this reason, I have adopted a “equality” criteria.
Typologie Number of Units Parking Places Gross Private Area (sqm) Terraces & Balconies Area (sqm)
T0 60 0 36 7
T1 60 0 45 9
T2 60 0 65 13
T3 60 0 78 16
Total 240 0 13440 2688
According to the rules that determine the minimum areas per typology, I am not presenting apartment dimensions that fit the regulation.
However, we are developing a Residential Product specifically for the rental market. The questions I ask are:
"Is it possible to create a T0 with 36 m2?"
"And a T1 apartment with 45 m2?"
"And a T2 apartment with 65 m2?"
"Finally, a T3 with 78 m2?"
The answer seems simple. Yes, it is possible. We have good examples in other European countries where the residential rental market "works" and the average dimensions per typology do not differ from those described.
Do we have some constraints in terms of space? Yes, we do. There is a great need to think about the layout of these houses so that every centimeter is used to the fullest.
Challenging? Yes.
Lack of habitability? No.
Regarding production costs, we “comeback” to the cost breakdown as we´ve done mentioned in "Program 1". Let´s compare:
1) Land Acquisition Costs: As in "Program 1," we leave this cost at 0;
Acquisition costs
Taxes
Technical and Legal Due Diligence
2) Project Costs, including VAT: 598,395.00 €
Preliminary Studies
Licensing Projects (Architecture and Engineering)
Execution Projects (Architecture and Engineering)
Energy Certification
Acoustic Certification
Other Certifications
3) Municipal Fees: 1,770,718.74 €
TRIU (Tax for Realization, Maintenance and Reinforcement of Urban Infrastructures)
Occupation of Public Roads
Fees for "Projects and Requests" Submission
IMI (Municipal Property Tax) and AIMI (Additional to Municipal Property Tax)
4) Construction Costs, including VAT: 18,959,370.40 €
Civil Construction and Materials Contracts
Infrastructure (Water, Electricity, Sanitation, Gas, Telecommunications)
Works Supervision
Insurance
Impredictables
Policing/Security
5) Project Management and Administration Costs, Including Taxes: 910,021.06 €
Operating Costs/Structure Costs
Outsourcing Costs
6) Financing Costs: 1,704,952.07 €
Procedural Fees
Stamp Duty on Used Capital
Interest
7) Marketing and Commercialization Costs: To simplify, we will leave this cost at 0, as we did with the land.
Marketing Materials
Real Estate Brokerage
The "new Architectural program" and the Construction VAT reduction (from 23% to 6%) allowed us to achieve some interesting objectives, which I will list:
Reduce total costs by about 3,080,808.14 €, approximately 12.9%, significantly reducing the cost per typology.
Program 1 Program 2 Cost Reduction
T0 75 980,08 € 64 134,26 € 12%
T1 114 996,87 € 80 167,83 € 35%
T2 164 281,25 € 115 797,97 € 34%
T3 236 154,30 € 138 957,56 € 60%
Total Cost 27 024 265,41 € 23 943 457,27 € 12,9%
2. Increase the number of apartments by approximately 37%, from 175 to 240 units, without increasing the Building Footprint or Gross Construction Area.
Program 1 Program 2
Tipology Number of Units Tipology Number of units
T0 30 T0 60
T1 25 T1 60
T2 90 T2 60
T3 30 T3 60
Total 175 Total 240
3. Reduce area per tipology, creating a more compact product.
Total Area Per Tipology Program 1 (sqm) Total Area Per Tipology Program 1 (sqm) Areas Reduction
T0 44,40 43,20 2,8%
T1 67,00 54,00 24,1%
T2 96,00 78,00 23,1%
T3 138,00 93,60 47,4%
4. Reduce monthly rents per typology, slightly increasing the total annual rent.
Monthly Rent Program 1 Monthly Rent Program 2 Monthly Rent Reduction
T0 380 € 374 € 1,5%
T1 575 € 468 € 23,0%
T2 821 € 675 € 21,6%
T3 1 181 € 811 € 45,7%
Renda Total Anual 1 621 455,92 € 1 676 042,01 €
5. Improving project performance by significantly increasing Yield.
Yield Program 1 Yield Program 2 Positive Variation
T0 6% 7,0% 16,7%
T1 6% 7,0% 16,7%
T2 6% 7,0% 16,7%
T3 6% 7,0% 16,7%
Summaryzing :
We cannot reduce the value of rental housing if we do not increase the supply in the rental market.
To increase the supply of this asset class, it is necessary to create conditions to attract investment. The premises of STABILITY AND PROFITABILITY are fundamental to the success of the initiative.
“Investors appetite” to allocate capital to the urban rental market (Built to Rent) has increased significantly in recent years.
The exercises presented, although fictional and very simplified, demonstrate the impact that the reduction of Construction VAT and special licensing conditions in terms of the number of units and areas per typology can mean for investment performance.
The problem of access to housing exists and will tend to worsen if inertia continues.
We can continue to blame Airbnb, Golden Visa, Real Estate Speculation, and so on... We will not solve anything if we do not create conditions that result from serious and strategic planning.
A "clear" example of the lack of effectiveness of measures taken was the creation of containment zones for Airbnb in 2019. In Lisbon, 4 years have passed and the only result I see is the proliferation of illegal accommodation in many of these areas. Today, we have a growing market based on the hot bed system, in which dozens of people sleep in the same bed, in the same house at different times in a day.
It seems clear to me that we can create solutions without reinventing the wheel. Perhaps it makes sense to understand what has been done in other European countries to develop their rental markets.
Alternatively, we can continue to complain about everything and everyone and argue whether the egg or the chicken was born first.
See you soon,
André Casaca
