Build to rent can be a viable asset class: let’s get it right
David Chandler, Western Sydney University | 7 September 2017
Australia’s inevitable drift to rental was well forecast by Owen Donald’s National Housing Supply Council in its second State of Supply report (2010). The Council indicated demand for rental growing to 2.72 million dwellings by 2019, an increase of 26 per cent from a 2009 baseline.
Perhaps the acuity of dwelling cost was not as anticipated, nor perhaps was the rapid shift to higher density dwellings fuelled by infrastructure investment, low interest rates and developer pressure on governments to uncap restrictive density controls.
There is now a sense that the demand side for new density dwellings may be coming off the boil. To backfill quelling development momentum, it was predictable that Build-to-Rent (BtR) would get a look in at some time. A professional asset class in BtR has been missing in Australia.
Build to rent is not new phenomenon
Harry Triguboff’s Meriton Group is Australia’s largest apartment developer. Triguboff established Meriton Rental Apartments in 2000 and now has over 6000 properties for lease across Sydney, Brisbane and the Gold Coast.
This was and remains a classic counter-cyclical play to maintain development momentum and to ensure minimal developed value leakage.
The company should be the benchmark in testing the viability of BtR portfolios. Its product quality is well-positioned to suit rental, being less aspirational than much of the top-end retail product now looking to achieve more than $12,000 a square metre.
It’s an efficient builder whose cost of construction is possibly 15-20 per cent lower than that of other companies now mentioned as being interested in this space. Triguboff is a seasoned asset manager who claims he has quality construction as a “house-rule” these days, as he now holds stock for over seven years.
It’s possible that Meriton has achieved a net cash yield of over eight per cent and a total return of 20 per cent plus for the last 10 years. This model would be hard to emulate in so many ways.
In addition to the growing portfolios of community housing originated rental stock, there is a number of high-net-worth syndicates who have quietly put together impressive rental portfolios by selectively buying during the cycles, often from distressed vendors caught with too much stock at the top of the market.
Expect this portfolio build method to repeat, but also understand that the type and quality of stock in these portfolios can vary widely. These are not the core dwellings that are needed to build appreciating BtR stock. This was the lesson learned in the US by first movers in build-to-rent.
Smart, well-run portfolios require proven designs, standards, procurement methodologies and predictable maintenance and operational plans. Most of the US top 50 rental Real Estate Investment Trusts (REITs) in this space have cleaned up their portfolios.
Don’t overlook the student housing model
The Student Housing Model (SHM) should not be overlooked in considering BtR portfolio assemblies. These rental accommodation projects have mostly occurred on land owned and retained by universities.
In this model, the developer builds and operates these projects for a concession period of 20-25 years and, at the end, they revert to the university. There are several transferable features of SHM that can inform the formation and operation of a BtR asset class. Amongst the most important is the renter–operator relationships and protocols.
There have been some half-hearted attempts, such as NRAS
The former Labour government ventured into attempting to incentivise institutional interest in affordable BtR, in a program called the National Rental Affordability Scheme (NRAS).
They got it wrong and were told bluntly by institutions that this was not an asset class. NRAS had none of the features that underpin an investment of this nature. NRAS mutated into an expensive temporary boost to affordable housing supply, that is easily spotted.
Amongst these are many shoddy developments spawned in a desperate attempt to deliver NRAS via unsophisticated developers.
Tragically, in many cases this stock is now nearing the end of the NRAS concession period, which could see as many as 20,000 dwellings come back onto the market as investors look to cash out on the capital growth they have locked in, and to avoid the looming capex [capital expenditure] that will be required to attend to accrued maintenance backlogs.
There have been several detailed BtR research and investment proposals made to institutions for this potential asset class over the past 15 years.
Critically, these proposals addressed the key “ways-in”, “stay-in” and “ways-out” investment criteria that institutions must see. These proposals suggested total returns of 8-10 per cent for plus seven-year minimum hold periods.
Essentially, this asset class must be seen as an indexed annuity surrogate that offers low risk and steady growth returns over the long term by proven developers and managers who look to balance portfolio churn (the way out) with the challenge of recycling investor commitment to the sector – the “way-in, stay-in” fundamentals.
During that time developers were more minded to press on with their traditional business model, which saw profits taken at the end of the build period, not 7-10 years down the track.
Another challenge for traditional developers is that build-to-rent portfolios require sophistication and a commitment to quality, assured and desirable buildings that appreciate over time. Not leaving town at the end of the defects and warranty period.
A new housing supply culture is needed
During the current Senate inquiry into non-conforming building products, the Owners Corporation Network pointed to evidence its had gathered that 75 per cent of new residential buildings had significant defects.
Using NSW as an example, there are more than 72,000 registered strata schemes in the state, with a combined asset value of more than $350 billion. Strata schemes represent a store of our national wealth, exceeding $1 trillion nationally. Across NSW, two million people now live within strata title dwellings.
Within 20 years it is expected that half of NSW’s population will be living or working in strata or community title schemes. These are the core types of properties that would make up future build-to-rent portfolios. So, a significant build quality culture change would be needed, as would investment in more sustainable, functional buildings.
We now find the residential industry sensing the end of days for part of their current build-to-sell development pipelines.
Government is also sensitive to the potential impact of a downturn in construction activity and revenues from the sale of infrastructure dependent sites, fees and taxes. And governments everywhere are under pressure to address the need for more achievable housing, that is, rental in the short-to-medium term and ownership later in the housing achievement cycle.
While pouring large amounts of money into social housing for the neediest is justified, this solution should not become an institutionalised model to house those whose needs may be progressively assisted towards eventual housing certainty either in rental or ownership.
There are some bold decisions to be made to enable new housing supplies that avoid creating a widening dependent housing class.
Well-targeted private sector led BtR can be part of the bridge that households may cross, on their housing achievement journey. This type of stock can be the foundation of a viable BtR asset class.
The US model is worth studying
The US model offers a credible model upon which to foster a sustainable and attractive asset class in BtR. The representation of the US Multi-Family housing sector as it is known is the National Multi-Housing Council (NMHC). It describe itself as:
“The place where the leaders of the apartment industry come together to guide their future success. With the industry’s most prominent and creative leaders at the helm, NMHC provides a forum for insight, advocacy and action that enable both members and the communities they build to thrive.”
The success of BtR in the US comes from a collective action of like-minded organisations – both for-profit and not-for-profit, which place their investor and customer interests at the top of the order.
This is not a home for developers looking for a “port-in-a-storm”.
It is worth exploring the NMHC website to see just how investor and renter-customer centric the US BtR sector has become.
Serious long-term institutional investors can be assured by the published benchmarks of the council that cover operational costs, returns to investors, renter satisfaction, vacancy, maintenance and energy consumption to name a few, before they invest. The best of breed get rewarded.
This model does not happen overnight.
National government leadership is fundamental
Governments should not be hoodwinked by lobbying from individual developer interests or their associations who have for a long-time harboured a distaste for the rental class.
Establishing a viable BtR asset class needs an industry strategy that should be directed to commitment to commencing upwards of 50,000 dwellings within five years and a resolve to grow this to 200,000 dwellings within 15 years.
This would still be a drop in the bucket of overall supply need, but with an average delivered stock cost of say $500,000, the economic value, possibly $100 billion-plus when combined with the social and industry maturity impacts, would be profound.
It is likely that that impact may help abate some of the industry’s unsustainable speculative practices. It will drive improved construction innovation and quality as more longer-term looking clients demand smarter more functional buildings – buildings more suited for purpose and liveability. Rental, with more renter certainty.
But government must step up to the plate visibly and accountably. Establishing a viable BtR sector in Australia is a late onto the block additive to the Australian housing mix. BtR is well established in the US, the UK, Europe and in several Asian markets. Starting from the ground-up requires national leadership, not a series of state based closed industry engagements that will only respond to their political and local agency imperatives.
The development industry still has mixed views about BtR. Circling the current narrative is how to put institutional investors on an equal tax footing with mums and dad investors, achieving nationally consistent tenancy legislation that makes managing large multi-jurisdiction portfolios practical, ensuring a priority pipeline of well-located development sites, accommodating the up-REIT/down-REIT functions of the sector while creating incentives at state and investment level for at least the first 50,000 dwellings to help hot-start a sector that is critical to facilitating an achievable beginning for BtR to flourish.
David Chandler is Adjunct Professor, housing and construction practitioner, industry engagement lead at the Centre for Smart Modern Construction, School of Computing, Engineering and Mathematics, Western Sydney University.