Local co-CEO Dan McLennan talks affordable Build to Rent

How can BTR increase affordable housing supply?

While commercial BTR developments deliver a welcome increase in overall rental supply, the most urgently required supply of homes is for households on low to moderate incomes.

For these households, BTR projects may very well increase their housing options (and improve tenure security), but they may still need to get support through subsidies such as Commonwealth Rent Assistance (CRA) in order to afford the rent.

There are, however, some very important advances in increasing the numbers of affordable dwellings in BTR projects, including a growing clutch of investors and developers setting their own targets. Local, which was founded by Dan McLennan and Matt Berg, is one such company, committed to including at least 10 per cent of impact housing in all their projects which includes affordable housing, and also, where practical, a percentage of social housing dwellings and specialist disability accommodation (SDA).

‘We include minimum of 10 per cent impact housing regardless of any planning obligations, and we’re working on getting up to 30 per cent where possible,’ says Dan McLennan. ‘For example, we’re doing a development in Kensington (Victoria) of 477 units: 15 units have been designed to provide SDA housing for 14 residents plus onsite overnight assistance, 11 are social housing to be managed by a community housing provider and 22 are affordable units to be rented out to lower to moderate income households at 75 per cent of market rent or 30 per cent of household income, whichever is lower.’

What are the benefits for investors of delivering affordable housing?

'What we find is that although we’re getting less rent upfront for affordable housing units, the weighted risk on that investment is lower. Although the tenants are in the low to moderate income band, they have secure employment and a reliable income, they want tenure security, they’re not likely to default on rental and they’re comfortable living with a lower rent so are not likely to go anywhere.’

‘If you compare it to market rental housing, the risk is lower. Indeed, the higher you go up the rental scale the greater the risk attached. We saw this during COVID; it was the high-end CBD and inner city markets that experienced most volatility. People who can afford a luxury rental are more likely to be able to own a property, they have more lifestyle choice, so, consequently, may not be long term tenants, affecting the quality of the income stream from those properties. There can be more down time to relet properties, with the extra costs of attracting and processing new tenants.’

What role do government subsidies play?

‘For our projects targeting 10 per cent of impact housing, we’re not relying on any government subsidies. Including larger numbers of affordable housing units in projects will likely require some government support to achieve an acceptable risk weighted return for investors.

‘In particular if you’re going from 30 per cent to something like 100 per cent of affordable housing then you’re going to need a lot more contribution in that space,’ says McLennan. ‘But there are a lot of levers governments have got, both federally and at a state level, that can help bridge that economic gap – not just subsidies. This could take the form of planning bonuses (eg permitted enabling larger developments which include affordable housing); stamp duty, land tax and council rates reductions; as well as federal tax concessions.’

Is BTR a viable way to deliver good quality affordable housing?

Having contributed to the creation of over 300 affordable rental apartments in recent years, McLennan is confident that BTR can deliver good quality affordable housing for Australian households.

He says for Local, the financing balancing act of providing affordable and social housing is key.

‘Incorporating 10 per cent of impact housing in our projects comes at a meaningful cost,’ says McLennan. ‘But that investment goes to our broader market proposition. We believe, and our undertaken research tells us, that our market-rate customers will be aligned with Local’s values and engaged with the proposition that their rental is not just servicing their landlord’s negatively geared mortgage but is also contributing towards positive change.’

‘We think it’s good business, and we’ve found it’s been really well-received in terms of debt finance arrangements. Our banks in Australia are keen to identify opportunities to fund the creation of social and affordable housing. In particular, National Australia Bank (NAB) is the debt financier of our first two projects and has noted the importance of our socially conscious model in their decision to finance our projects.’

What about social housing - does BTR work there too?

Local works with community housing providers (CHPs) to manage and support affordable, social and SDA tenants in their BTR projects.

‘The rationale is that we really wanted to include these types of housing when setting up the business because we knew that was high impact, and we thought social is where you can genuinely say you’re changing lives,’ says McLennan. ‘On the flipside with social housing it’s a very modest rental. If there is market demand, we’ll include SDA housing where we can get an additional income from those apartments and use that to offset the provision of social housing.’

For SDA tenants, Local gets a rental contribution from the residents of 25 per cent of Disability Support Pension plus CRA, with the balance of the rental income coming from the National Disability Insurance Scheme (NDIS).

‘If our SDA dwellings are fully occupied, we can get an enhanced yield through NDIS, but we’re taking a greater risk because we need to incorporate a number of specialist support features into the dwellings’, says McLennan. ‘In addition, we only get NDIS income when we have a tenant in occupation. We’re hopeful our product will be really good in that space and we’ll be able to attract long term residents who will receive the same benefits of BTR that any other resident in the building would get.’

The BTR sector in Australia is small, how much can we expect it to grow?

BTR is starting to grow in Australia. A 2022 report identified that the BTR sector in Australia was worth $16.87 billion, and comprises ‘roughly 0.2 per cent of the total value of the residential housing sector’, with 23,000 apartments either completed (3,900 units) or in development (over 19,000 units).

‘I can see the Australian BTR market growing to be about 150,000 dwellings within ten years,’ says McLennan. ‘That’s really not a stretch target; it would be about one per cent of the housing market, and would be tracking approximately where the UK is at the moment.’

‘There are a couple of things that are going to drive that BTR growth, including the changes the Federal Government has made to tax on international managed investment trusts. It’s a massive shift. We spoke to offshore investors who didn’t want to participate in the market until that tax shift had happened. So, it’s unlocked a lot of liquidity and helped the sector grow beyond the initial first mover entrepreneurial style investors.’

In the 2023 Federal Budget, the Australian Government, to encourage investment in BTR, reduced the withholding tax penalties for international investors who use managed investment trusts (MITs) for investing in BTR. This puts BTR investments on the same taxation rate as other property investment options for foreign investors such as retail, hotels and commercial office buildings.

The changes will also support BTR investment by Australian investment entities such as superannuation funds.

‘Encouraging foreign MITs also helps the local investors’, says McLennan. ‘Now, for Australian investors, the potential market for BTR investors grows. This means domestic investors will have confidence that there will be a broad range of buyers should they wish to sell their investment, not just other Australian investors. And the reality is, there’s a lot more capital in the world outside Australia than there is in Australia. Overall, BTR works best for investors who want to invest for a long term, not for investors who want to constantly be recycling their money.’

What can Australian governments be doing to encourage local investment in BTR?

To encourage local funding entities, such as superannuation funds, to invest in BTR, McLennan says governments need to address some of the regulatory barriers which are inadvertently discouraging domestic investment.

‘For instance, presently, the ‘Your Future Your Super’ performance benchmark test for superannuation funds does not contemplate investment in BTR property' says Dan McLennan. This creates a potential disincentive for some super funds to invest in BTR versus sectors such as office and retail where performance can be tracked against the benchmark. Put another way, there can be no recognition for outperforming a benchmark if it doesn’t exist.

In addition, investments in property trigger stamp duty which is required to be disclosed under ASIC’s Regulatory Guide 97, unlike other types of taxes. Whilst this is not a BTR specific issue, this is an unnecessary obstacle for our super funds to invest directly in BTR and affordable housing more generally.'

* Local is a for-profit Australian BTR provider that provides sustainable rental communities that incorporate social, affordable and specialist disability accommodation alongside mainstream market rental product. The company’s aim is ‘to empower Australians to live a sustainable and socially conscious lifestyle’.