Purpose-built rental properties, commonly known as ‘build-to-rent’ in Australia, are considered an essential component of the housing market in most sophisticated economies.
In order to address an increasing demand for rental properties that the economic impacts of COVID-19 will only accelerate, a wider range of housing types, tenures and price points is needed in Australia, particularly in urban locations. Could build-to-rent be the solution to broadening Australia’s housing horizons?
In comparison to other nations around the world, Australia does not offer a large degree of variety when it comes to housing alternatives. Our East Coast capital cities – namely Sydney and Melbourne – are considered to be some of the least affordable housing markets in the world, offering next to no purpose-built, professionally managed rental housing. With decades of buy-to-let investor activity in the past, Australia’s residential sector is fragmented, with almost all private rented accommodation in the hands of individual landlords.
In recent years, a shift towards rental housing has swept across the globe. The combination of personal preferences and demographic trends, as well as constraints on purchase affordability, has meant that more individuals are not only renting, but renting for longer periods of time. This move towards rental accommodation is most pertinent to younger generations, but as the millennial generation ages, demand for rental properties will become multi-generational and continue to grow.
What is build-to-rent?
Most sophisticated economies consider purpose-built rental housing properties, commonly known as build-to-rent (BTR) in Australia, an essential component of their housing market. The United States (and many other nations which have an established market) refer to this asset class as ‘multi-family’ as multiple families live in a single building (with one owner). The term BTR reflects the nascent nature of this asset class in Australia – we don’t have existing assets and, as such, new buildings are being built for the purpose of renting, rather than for the traditional purpose of selling.
BTR properties are large scale developments with a single owner who designs and procures construction with the intention of long-term ownership. They are developer-owned and managed on-site, offering amenities and services, community programing and 24/7 maintenance for residents, and give residents the opportunity to engage in a long-term, undisturbed tenancy in their apartments.
BTR housing represents an efficient use of land by bringing positive economic multipliers for the communities where such properties are developed. Given the increasing scale and ownership of BTR, this form of housing lends itself to major mixed-use urban renewal and could serve as a catalyst to attract other forms of investment to areas and precincts, as well as promote infrastructure investment. An advantage of BTR projects is that they do not rely on pre-sales to finance their development, the consequence being that positive consumer sentiment is not needed in order to facilitate positive economic output. For this reason, BTR is beginning to gain favour with state governments and further announcements relating to the sector are expected in the coming months.
A macro view is needed
From an investment perspective, BTR is very similar to other types of income generating properties. However, unlike other classes of properties, leases in BTR buildings are generally shorter term with tenants who are not entities of substance. This means that the normal test of weighted average lease expiry (WALE) and concepts of tenant covenant and pre-commitment are not as relevant. What is relevant is a macro view of the market, vacancy rates and rents, a location, design and strategy that will attract and retain tenants, and a proactive manager who can minimise debtors and keep the vacancy rate low.
A shorter term WALE and turnover of tenants requires a new way of thinking from a financing perspective. For example, financiers of BTRs will need assurance regarding market demand for a project, the management arrangements of the property and the attractiveness of the building to tenants on an ongoing basis.
However, the progress of BTR off-shore and locally has shown that solutions are emerging. In off-shore markets, BTR housing has been categorised as a low-risk, core real estate asset class for institutional investment, providing for lower risks and lower yields over the long term. Since the model is dependent on occupancy and steady rental growth, owners are incentivised to deliver high quality product and amenities. This makes BTR attractive for superannuation, pension funds and risk-averse investors looking for returns over a period of decades. Locally, Qualitas has recently established a new fund backed by $125 million from the Clean Energy Finance Council for energy efficient, low-emissions BTR residential buildings. The BTR model incentivises adopting energy efficiency and renewable energy technologies as upfront costs are recouped during operations and in long-term asset value.
Recent bank financings in the BTR sector have taken the path of fund-through arrangements or development facilities converting to term facilities. Funding metrics have included the assessment of demand for the accommodation, sizing the overall facilities based on typical loan to development cost and loan to valuation (as if complete) metrics, as well as debt yield or forward-looking interest cover ratios based on expected occupancy and income. Once the development is complete, occupancy levels increase and income levels stabilise, the development facility converts to a term investment facility. This is not dissimilar to the approach taken on staff or student accommodation financings.
The BTR sector will also provide housing solutions for the affordable and social housing sector, supported by investment from superannuation, pension funds and the National Housing Finance and Investment Corporation.
Australian MIT tax regime
Foreign institutional investors generally invest in Australian real estate through managed investment trusts (MITs), which can generally avail themselves of concessional withholding tax rates on distributions to foreign investors.
In September 2017, however, the Commonwealth Government increased withholding taxes on residential investment (other than investments in affordable housing) from 15% to 30%. This is at odds with the position in other real estate asset classes such as student accommodation and boarding houses, which are considered commercial residential real estate and are taxed at a lower withholding tax rate. This tax position is a key impediment to the growth of BTR in Australia and in the past has been a point of difference from a policy perspective between the major federal political parties.
Jobs and economic activity need to be at the forefront of the Australian Government’s response to the economic impact of the COVID-19 pandemic. BTR can create thousands of construction and property management jobs almost immediately, and BTR properties also provide a greater sense of community, something that will be of increasing importance given the prevalence of feelings of isolation arising from the COVID-19 crisis.