Could 'Build to rent' create affordable rental housing?
‘Build to rent’ is an established practice in the UK and USA but has yet to be fully taken up in Australia
6 October 2017
With unaffordable housing being a growing issue of concern for Australians, a potential solution to increasing the supply of rental housing is the ‘Build to rent’ development route.
‘Build to rent’ is the process whereby developers and their financiers build multi-unit buildings and, instead of selling the units, retain them to rent to tenant households. Rents may be set at market rent or, for affordable and social housing, at an appropriate discount to market rents.
‘Build to rent’ is an established practice in both the UK and USA but has yet to be fully taken up in Australia. In 2002, AHURI research identified a number of barriers for institutional investment in the Australian market, reducing the attractiveness of 'build to rent' for investment by the large banks, insurance companies and the superannuation funds. These barriers, which reflected the market conditions at the time of the published research in the early 2000s, included:
- Low returns –The Australian private rental market is made up of a diverse collection of small landlords with a range of motivations for supplying rental housing. Consequently, income yield is seldom high enough to attract professional investors who are well informed about alternative investment opportunities yielding higher returns for equivalent or lower risk, except where tax shelters deliver adequate compensating benefits
- High risk – Rental investment generates significant and multiple risks associated with revenue flows, financing costs, operation and management, and public policy changes. It is this coupling of low returns with high risks that provides the basic barrier to institutional involvement in this sector
- High management costs – Property and tenancy management costs are high on a per dwelling basis. Institutions prefer to allocate large tranches of funds in order to spread transaction costs, including the heavy compliance and due diligence processes that must accompany their investment decisions. The rental sector as currently configured does not meet this requirement
- Illiquidity – All property assets are illiquid by comparison with asset classes like equities (shares). The institutions will invest in commercial property, directly and through company or trust structures, but generally require a premium on the rate of return
- Poor market information – Information on property values and their movement over time is incomplete and uneven in quality, by comparison to the minute-by-minute tracking of share prices, for example. This makes it difficult for investors to accurately calculate and price risk on property assets. Uncertainty replaces risk which tends to load a further premium on the required rate of return
- No track record – Allied to a lack of good market information, institutions have no real experience of large scale investment in rental housing in this country to judge outcomes. Untried investment niches normally require a pioneering investor and a ‘novelty’ premium on the rate of return.
All these reasons meant that, at the time of research, the risk-adjusted rate of return was insufficient to attract institutional investors into providing rental housing.
However, recent media coverage suggests that market conditions have changed and 'build to rent' has become a more attractive development option. One large developer, Mirvac, intends to raise $164 million to fund a seed project in Sydney Olympic Park and has three more potential projects, worth about $750 million when completed, on the drawing board. Mirvac expects to earn around 4.5 per cent on its investment in these 'build to rent' projects, which, given current and predicted long-term interest rates, is an economically viable rate of return.
While such developments will increase overall rental supply, they may not necessarily target rental properties for lower income households. To increase the supply of affordable rental and social housing, governments at all levels will need to provide economic support to developers, such as through tax incentives, discounted ex-government land or changes to planning laws that allow developers to increase site densities.
In mid-September 2017, Treasurer Scott Morrison outlined that Managed Investment Trusts (with their accompanying tax benefits, which some developers had seen as a way of improving their returns from ‘build to rent’ projects) would only be able to invest in residential ‘build to rent’ real estate if it was for affordable housing managed by an authorised community housing provider.
A session exploring ‘Build to rent’ will be presented at the National Housing Conference 2017. It will provide an opportunity to explore how the ‘build to rent’ model may work in the Australia and what government incentives or support may be needed to provide in order to increase the supply of affordable rental housing.