Plugging the Leaks: Why Operational Excellence is Key to Residential Performance

The recent spike in inflation has seen operational costs rise significantly in the last few years, adding pressure to net operating income. While rents have also grown to offset some of these increases, cost leakage as a percent of gross income across European residential has grown from a low of 21% in 2016 to above 25% in 2025 according to MSCI. This figure also masks considerable differences, dependent on country, subsector and quality that can range from less than 20% up to 50% of gross income. Less efficient stock, therefore, can have a considerable impact on an asset’s distributable income and overall performance.

Figure 1: Typical residential operational cost breakdown, excl. tenant recoverables

Underlying these differences is often a complex layer of individual cost lines, which can be broken down into four major categories: running, management, letting and other.

Within each of these categories there are costs we can control (directly and indirectly) and costs which are generally fixed. Fixed costs like property taxes and ground rents, for example, might be largely consistent for two equivalent assets in a single country, but maintenance and care costs for a modern asset compared to a twenty-year-old building will be drastically different. Management cost efficiencies can often indirectly be achieved through economies of scale, the proximity and number of assets within a local region and having fewer property managers across a portfolio.

A key focus for residential investors will be managing vacancy and on-site amenities (categorized in Other). These two factors typically go hand-in-hand, with tenant services helping to attract new tenants and decrease vacancy. The industry is also currently going through a period of discovery. Adding extra on-site amenities can be extremely costly if not targeted to the local demographic. Incorporation of expensive gyms or 24-hour concierge staff need to be weighed on a needs versus nice-to-have basis. Many families and young professionals are prioritizing lower-cost services that help build community or improve safety over and above more luxury add-ons.

The cost differences that we see are most often based on age, quality and location of an asset. Older standing assets, for example, can be notoriously “leaky” from an income perspective.

Figure 2: German residential net operating costs by building age, excl. tenant recoverables

Analysis of the German MSCI index shows that operational leakage between older assets built pre-1990 compared to modern assets built after 2009 is 70% higher per square meter (or a difference of 28% as a percentage of gross income). Day-to-day operations in newer buildings are more efficient, with lower maintenance and management costs.

‘Net other’ costs, however, tend to be marginally higher in newer buildings - nearly 40% of leakage costs in German residential assets built post 2009 fall into this category. The higher costs are, in part, driven by marginally higher vacancy, as new assets come online and take time to lease up and stabilize. Higher service and occupier costs will also alter the balance, with many modern-day amenities almost non-existent in early-generation stock.

Looking at these same costs over time highlights an important trend. Most assets will go through a similar journey over their lifetime, which requires constant oversight from the investor, and careful attention from the property manager to manage potential risks.

Figure 3: German residential net operating costs by building age, excl. tenant recoverables, three-year rolling average from end of each period to 2024, % of gross income

Operating leakage for newly completed assets usually starts higher while the asset stabilizes – taking anywhere from six months to several years. Stabilization depends on lease-up time and the quality of the local property manager during the first year, which tends to be more problematic as issues get resolved. Costs will generally moderate as vacancies are filled and the building enters standard day-to-day operations.

As the chart above shows, at some point building obsolescence begins to be an issue. Net rental revenue is reduced is reduced because higher levels of maintenance are required and on-site amenities need to be upgraded to cater to evolving needs.

For investors, including sufficient CAPEX for a long-term hold is important. Most core investors underwrite on a 10-year hold basis. A new build will need lower CAPEX during this period, but the exit strategy should factor this in for potential future buyers. Residential portfolios should also be continuously rejuvenated to ensure assets with 20% leakage don’t rise to 50%. This means incorporating a disciplined sales strategy to keep the portfolio quality at optimal operating levels.

Energy ratings are becoming increasingly critical in protecting an assets’ potential cash-flow. Given the recent spike in wholesale energy prices and potential future volatility due to ongoing geopolitical distress, managers need to work toward providing more efficient and secure energy across their portfolios to keep costs from rising.

Figure 4: Sweden gross electricity costs index, 100 = 2015

Data from Sweden shows the importance of holding higher quality, more energy efficient residential assets. Electricity costs between these two group types tracked each other relatively closely for the seven years prior to 2022. But the onset of the Ukraine war drove a 22% gap between the two. While energy costs within Residential A buildings still rose, landlords were vastly more protected from exogenous shocks.

We can see a similar pattern in the Netherlands, where we can split out residential performance by EPC rating. Operating costs per square meter in less energy efficient buildings averaged 21% higher for the last decade than in assets with an EPC of A or above. Over time, that drag on NOI growth can be quite substantial. For lower energy rated buildings, since 2012, operating costs grew 40% more and net operating income nearly 40% less than for buildings with greater energy efficiency.

Figure 5: Netherlands residential: NOI per sqm vs. OPEX per sqm by EPC label, 100 = 2012

As the European residential sector matures, investor portfolios reach scale and we move through this next cycle, greater attention is likely to be placed on stabilized performance and keeping a lid on costs. Assessing operating risks at both the portfolio and asset level, will be critical for regular buy-hold-sell analyses, as well as implementing cost reduction strategies that can drive the highest efficiencies.

Unfortunately for investors, there is no quick and easy win to achieving this. Often, simple economies of scale can lower costs considerably, by rolling out sustainability measures and tenant surveys on a platform-wide basis, rather than asset by asset. Buying assets which have an optimal number of units on a single site, or in markets where an existing local property manager is already in operation can also make a difference at a portfolio level. Equally the use of technology to create efficiencies is no longer just a nice to have, but rather an essential tool in managing day-to-day operations and streamlining services (see case study below).

At the asset level, we firmly believe that keeping tenants happy and in place for longer can not only reduce turnover and vacancy within a building but helps to ensure that the tenants themselves view the building as a long-term home, rather than short-term temporary accommodation. Given that overall maintenance and care can build to become a significant drag on income over time, anything that can be done to create a more engaged tenant base throughout the hold period may be able to delay this process.

Strategies which focus on new build or higher quality stock also have proven cost leakage benefits, with lower maintenance needs, high energy efficiency, as well as more efficient unit sizes and building layouts. But adding costly unnecessary amenities can erode these gains quickly. Year-round active management and sufficient CAPEX that is strategically injected will ensure even modern buildings are operating to their fullest potential.

At CBRE Investment Management, through a combination of our investor-operator approach, platform scale, local expertise and disciplined investment and cost management approach, we have successfully outperformed our equivalent European residential benchmark for lower operational costs for the last 15 years. Keeping operating costs lower has helped us deliver improved investment performance for our investors.

The European residential market is entering a period where investor performance is less about yield compression and driven more by enhancing net income. How operating costs are managed is, therefore, likely to come under greater scrutiny. How efficiently an asset operates should be a key decision metric in any residential strategy. Solving this issue requires on-the-ground expertise combined with platform-wide efficiencies. Investors need to have the discipline to buy and scale their residential exposure in markets and subsectors where these efficiencies are best achieved. No building can stay efficient forever, ignoring operational obsolescence will only create problems for long-term investors further down the line.