The affordable housing opportunity for Build to Rent residential

June 22, 2023
Market Thoughts & Insights

A version of this article was published in The Australian newspaper as an opinion piece 19th June, 2023

We see Government incentives to the BTR sector as a potential win / win. If incentives have the desired effect, Governments themselves will have less pressure to fund and build new dwellings directly.

This would appear to be the perfect way to spend some of the Federal Government’s proposed $2bn of funding to the states for affordable housing – the so-called Social Housing Accelerator plan. The intent and funding are both much needed – but the practicalities of actually building the required dwellings is the real challenge.

If you’ve ever had your residential lease terminated with the minimum number of days notice, you’ll quickly understand why Australia’s housing prices are so high. Unlike other regions in Asia Pacific such as Hong Kong and Singapore (two year leases standard) and Japan (effectively perpetual tenancy rights in many circumstances), Australia’s typical residential lease terms are short. Having to relocate a family, work through new school routes, daily routines and social networks, retrieve a security bond, outlay another, engage removalists and undertake a move is stressful and expensive. Do this too many times and you will do almost anything to own your own home. It is a very real issue for the almost one third of Australians that live in rented homes.

The problem of limited tenure and tenancy insecurity is even more profound for those families with limited financial resources. Moving is expensive. Stress and anxiety levels are further heightened when a family doesn’t have the financial resources to pay for a move and outlay another security deposit, assuming they can find a suitable new home to rent within weeks.

There have been many reasons put forward supporting the growth of a new sector in Australia – Built to Rent (BTR) residential. These include increasing housing supply nearer to city centres, lessening the cost and management burden of housing supply on Governments, enabling a sense of community and improving the overall quality of rental stock in the market. However, helping solve the limited tenure and tenancy insecurity problem in conjunction with providing an opportunity to quickly ramp up the supply of affordable housing are the biggest benefits in our view.

Professional, large scale BTR owners will effectively offer a tenant unofficial perpetual tenancy rights – something never systematically offered before in Australia. It is in the best interest of BTR landlords to minimise vacancy downtime. It is also less likely that a sale or major redevelopment will trigger a BTR landlord to issue a notice to vacate to a tenant. As a tenant, so long as you pay your rent and generally do the right thing, you are unlikely to ever be asked to vacate. Your rent is also unlikely to go up by an unreasonable amount either (relative to single rental assets in the broader rental market), in particular if the BTR complex consists of 100+ dwellings. The bigger the asset, the higher the likelihood there will be some frictional vacancy providing good tenants with options.

It is partly this security and diversification of income that is attracting developers and owners to the sector. The BTR sector is also particularly attractive given the prevailing weakness in office markets. The most significant market participants include Home, Mirvac, Qualitas, Greystar, Investa, UBS, Super Housing Partnerships and Blackstone. A large scale BTR asset offers the ultimate income diversification in addition to minimal incentives. Currently office incentives are around 30% in Sydney. So, that’s three years rent free equivalent on a ten year lease. Imagine receiving that incentive as a residential tenant. Typical residential incentives are effectively zero. Landlord maintenance costs are low. The downside for BTR for investors is the lack of average lease tenure relative to office and retail leases. However as we have just written above – families love the idea of unofficial perpetual tenancy rights, so while some more transient tenants will move around, many families will stay in their dwellings for years.

The other challenge for developers is generating sufficient underlying unlevered internal rates of return (IRRs). IRRs for off-shore investors will be greatly helped the Australian Government’s recent announcement to lower the Managed Investment Trust (MIT) withholding tax rate from 30% to 15% for build-to-rent housing projects, effectively adding around 1% to post tax IRRs for some foreign sources of capital. A recent study by Ernst & Young showed levelling the withholding tax rate, in line with investment in other property asset classes, could create an extra 150,000 Australian homes over the next decade.

BTR the key for the provision of affordable housing

While much has made of the fact that BTR can help solve Australia’s housing shortage, one of the main benefits of the growth of the BTR sector in our view, is the ability to quickly and efficiently ramp up the provision of affordable housing in Australia. This can be in the form of key worker housing or housing with an effective rent cap. Of companies in our investment universe, Mirvac has allocated 25% of its Liv Anura (99 apartments) for affordable housing with rents set below market levels with the Queensland State Government picking up the difference between the rent paid and the market level of rent.

However there is a major challenge for the sector. In most cases a new BTR asset will set its rents at a premium to the overall secondary or individual landlord market in the same area. This makes sense as the product is new, of a higher quality and offers a range of extra facilities (gym, concierge, on site maintenance, parcel rooms and so on). Developers will also argue that renters can rent a smaller dwelling in a BTR facility relative to the secondary market given tenant access to shared recreation areas. Investors also need commercial rates of return and BTR IRRs are tight. Above market rents are typically required. Yes it makes financial sense, but that doesn’t help those that can’t find a apartment to rent or have the means to pay market (or above market) rentals.

This is where the Federal and State Governments need to step in. We see Government incentives to the sector as a potential win / win. If incentives have the desired effect, Governments themselves will have less pressure to fund and build new dwellings directly.

This would appear to be the perfect way to spend some of the Federal Government’s proposed $2bn of funding to the states for affordable housing – the so-called Social Housing Accelerator plan. The intent and funding is much needed – but the practicalities of actually building the required dwellings is the real challenge.

We see three broad solutions (in addition to the recently announcement of the withholding tax changes):

1. State Governments to adopt planning responsibility for large BTR projects (say, 300+ apartment developments). One key diver of the current lack of dwelling supply, is the slow, expensive and overly bureaucratic local Council Development Application approval process. It appears the system is currently at breaking point with approval times blowing out and the prevailing attitude appearing to be that the development of more housing is needed, so long as it isn’t built near me! State Governments need to take control and should be the approval authority for all large BTR projects.

It appears our first solution is coming closer to becoming reality. The NSW State Government recently announced a new suite of polices aimed at increasing the provision of social housing. For housing developments valued at more than $75m that include a minimum of 15% affordable housing, the government will offer access to a new “state significant development” pathway. This means planning decisions will be fast-tracked and will effectively by-pass local Councils. It is unclear how affordable housing” will be defined.

These developments will also be offered access to an additional 30% floor space ratio, increasing the size of the development and access to a height bonus of 30% above Local Environment Plans (LEPs).

2. State Governments to allocate additional funding to BTR affordable/essential worker housing. Some or all of this could be funded by the Federal Government’s recent Social Housing Accelerator announcement. Utilising a similar model to Mirvac at Liv Anura, State Governments can efficiently cater for additional affordable housing in a capital light way. $150m per annum enables 20,000 subsidised affordable dwellings. The developer is made whole via subsidised rent, only one management group is needed to manage the completed asset and the NSW State Government (by way of example) would need to allocate just 0.15% of its state budget to provide a critical service to essential workers or families in specific income brackets.

3. Federal Government loans and GST tax concessions. The provision of low cost loans under certain criteria could encourage the provision of a higher proportion affordable apartments within a BTR development. Putting BTR developments on a level playing field with other commercial property asset classes could lead to partial or full GST recoverability, effectively reducing capital costs and increasing the incentive to develop.

If Australia is to have any chance of achieving the Albanese Government’s shared ambition to build “one million new well-located homes over five years from 2024”, the BTR sector will need to do much of the heavy lifting, only possible with the right incentives in place.

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