The great Australian dream of home ownership is a tired and outdated concept. Most Millennials and Gen Zs have let go of the idea of wanting a home, and even if they could afford a deposit, many are anxious about the prospect of tying up all their wealth in a single asset like their Boomer parents did.
ABS Census data point to a decline in the number of people who own a home outright, which fell to 31 per cent in 2021 from 35 per cent a decade earlier. Correspondingly, 31 per cent of the population were renters in 2021 versus 29 per cent in 2011.
This is a fundamental shift in the way people view their homes, and it’s not going to change any time soon. In an environment where strong migration and high construction costs are conspiring to limit the supply of homes and rents are escalating, it’s time for developers to rethink how they bring properties to market.
Build to Rent, while common in overseas countries such as the US and the UK, has not gained much traction in Australia. The two main deterrents have been that yields are too low versus commercial property, and developer taxes are too high compared to Build to Sell.
Last week the federal government aimed to alleviate the latter issue by reducing the withholding tax that foreign investors pay on a BTR development to 15 per cent, down from 30 per cent, in response to frenzied lobbying from the industry.
Research by EY and commissioned by the Property Council of Australia as part of the lobbying blitz posited that the tax change would promote the development of 150,000 new BTR units over the next 10 years, boosting the number of projects in the pipeline from a paltry 11 to 72.
Yields remain low – average capitalisation rates for BTR are 3.75 per cent to 4.25 per cent but this is fine for pension and superannuation funds which target returns in line with CPI and over a longer investment horizon. In Australia, foreign investors are the main participants in BTR.
Filling in the “missing middle”
There is a lot to like about BTR. If done smartly, it can help fill in the “missing middle” by locating new developments in middle ring suburbs with proximity to transport infrastructure and lifestyle amenities, helping to manage the ever-expanding footprint of our capital cities.
BTR comes in to its own at times of high interest rates and low construction activity, and is therefore a good countercyclical option for developers whose projects would not otherwise stack up at the present time of high interest rates and construction price escalation.
But let’s not confuse BTR with affordable housing. The EY research found that BTR typically commands 10-15 per cent higher rents compared to private rentals.
“Mum and dad” investors are the main owners of Australia’s real estate. Some 57 per cent of Australia’s wealth – $9.3 trillion – is tied up in residential real estate this way.
Yet despite its potential, The BTR industry is worth $16.8 billion in Australia, accounting for just 0.2 per cent of Australia’s residential property sector, according to EY.
If BTR grew from its present size to 3 per cent of Australia’s residential stock, it would unlock an investment motza ball to the tune of $290 billion.
A level playing field?
Reducing the tax burden for foreign investors is a step in the right direction, but the MIT change won’t benefit local investors. And all BTR developers are still subject to GST on the cost of their construction inputs and are unable to pass it on to the customer the way other developers do.
Financing is an important consideration, given that BTR ties up funds for a longer period because the investor/developer retains the title to the apartments. For this reason, BTR has a different risk profile compared to other asset classes, and investors must adopt a longer term horizon. An Allens paper on BTR advises that banks will tend to offer finance based on a lower debt to equity ratio compared to a traditional residential development.
However, some developers say using the BTR model has actually worked in their favour. St George Community Housing chief Scott Langford says that being a BTR developer can be advantageous because unlike in traditional developments where the developer is depending on all the buyers to settle on their sale contracts, for a BTR the bank is dealing with a single counterparty.
One of the benefits of the tight rental market is that it creates an “underlying demand for quality rentals – there is a clear view that there won’t be any trouble letting the units,” Langford adds.
The long-hold nature of BTR is better suited to patient capital such as super funds who can accept a lower yield.
Law firm Allens proposes a “fund through” model, where investors contract a developer, builder, and operator to design, construct and maintain the property, while the investor signs tenancy agreements.
This model means investors are raising the debt finance with their credit rating, rather than the developers, who are then free to pursue other projects. It will allow investors to offer longer-term leases than would otherwise be available on the market.
In the UK, what is known as the Private Rented Sector (PRS) is now the second largest form of housing tenure. The model has worked well in expensive cities like London, where the cost of home ownership is high, and work and leisure opportunities are centralised.
Sustainability and ESG dividends
St George has partnered with French insurer AXA IM Alts on a 400-unit development at Westmead in Sydney’s western suburbs, which will include a mix of at-market and affordable housing aimed at providing for key workers in the nearby hospital precinct.
Langford says the yields are lower than on an ordinary residential development, but that AXA IM Alts is prepared for this with a long-term investment horizon and a strong “ESG lens” (environmental, social and governance) where it is as concerned with the environmental and social sustainability of the project as its financial performance.
BTRs are a great option for young urban professionals, but developments tend to perform better when they are aimed at the higher end of the market, rather than in the affordable space where they are most needed.
On its own, the MIT change is not going to solve the housing affordability crisis in Australia, because developers will still lack the incentive to provide affordable housing.
The UK experience suggests that other housing policy reform is needed, such as planning policies where minimum numbers of affordable housing are required per project. Currently there are no such requirements in Australian planning instruments.