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Unpacking the Build to Rent portfolio

apartments against sky

Build to Rent could become a strategically important contributor to the future housing landscape, helping renters to obtain secure, relatively affordable housing, while providing a stable, long-term investment. But the government needs to step up to make it an attractive proposition.

In unpacking the Build to Rent (BtR) sector, first we need to question what the problem is that needs solving, and then think about what part of Australia’s housing challenges a new asset class in BtR might address.

A snapshot of the problem

 Overall home ownership in Australia is at a 60-year low. In 1982, 62 per cent of people aged 25-34 owned their own home. By 2012, this had declined to just 42 per cent. Australians who owned their own home outright declined to 31 per cent by 2012.

In contrast those renting increased slightly from 29.6 per cent to 30.9 per cent by 2016. They were paying more, with the median household weekly rent jumping from $285 to $335. The total demand for rental housing in Australia is forecast to rise to 2.72 million dwellings by 2019. Increasingly, rental dwellings are part of the higher density housing mix.

The percentage of households now paying more than 30 per cent of their income in rent has also increased, rising from 10.4 per cent in 2012 to 11.5 per cent in 2016.

Over the last 25 years, young people have gone from having to pay five times to now up to 15 times their annual income to purchase a new home.

There is a strong case for a new additive to the housing supply mix. BtR has this potential.

There are several BtR models being canvassed

A reported BtR model describes a net cash return of 4.5 per cent for a new fully let asset. A BtR club is proposed that may involve $750 million being invested across four projects. The first might include 257 apartments, have a completed cost of $163 million and a completed valuation of $179 million. This model could provide investors with approximately a 9.8 per cent discount to market for the first asset into the BtR club.

This suggests that an average apartment may have a cost price of $634,000. Prices would vary across a mix of studio, one-bedroom, two-bedroom, two-bedroom-plus and three-bedroom apartments, with a concentration on smaller apartments. It could be assumed that an average apartment may be 90 square metres in size. This being the case, the delivered cost could be near $7000 a sq m and underpin a retail value of $8500 a sq m.

This looks like a reasonably fair portfolio-build proposition. Typically, a developer would expect to achieve a 20 per cent margin on the cost of their developments. This is their reasonable price to cover a return for site acquisition, achieving development consent and construction risk, plus the usual sales, marketing, finance and related transaction risks.

In this instance, there is no sales risk as BtR properties are offered in a single line to the institutional investment club. There is reduced finance risk and other savings to normal developer transaction costs due to dealing with an investor syndicate. Institutions have no appetite for portfolio assembly risk, and they have no appetite for competing with developers in bidding for undeveloped sites. This model deals with the first hurdle often described as the “way-in”. The “stay-in” and “way-out” arrangements are also canvassed.

The model indicates a minimum stay-in period of seven years and a total investor return of 10 per cent (IRR). The portfolio sponsor would commit to provide 10 per cent of the equity and the investment club, the balance. No debt is envisaged. There are no available details on the assumptions used for rental growth, average vacancy factor, operating overheads and capital growth. There is general industry acknowledgement that BtR is a relatively low-risk investment for quality, well-managed portfolios when compared to other asset classes. BtR is typically viewed as an acceptable surrogate for a long-term indexed annuity income stream. This is a well-supported asset class internationally.

Experience of BtR in the US Multi-Family REIT market suggests that the operating costs of portfolios is in the order of 30 per cent. A net cash yield needs to be bulked up accordingly. Australian portfolios might assume rental growth of 2.5 to 3.5 per cent a year. Capital growth may be 3.5 to 4.5 per cent, but this may be moderated when portfolios are created near the top of the cycle. In this instance, the average starting gross rental may be about $700 a week.

A BtR sector may negotiate with government for concessional tax, depreciation and other incentives that enhance investor returns and encourage first mover developers to commit. Other useful actions could be taken by government. These may include priority land access and payment term concessions for foundation assets. Others may include introducing rental vouchers to assist lower income renters to access this stock in similar ways to overseas models. This is a very efficient way for governments to provide flexible help to renters. There will be resistance from some, but that’s life.

For the purpose of researching this article, information from the US body that represents the sector known as the National Multi-Housing Council (NMHC), and details of properties, rental terms and investor information for Equity Residential (EQR) and Avalon Bay Communities (AVB) have been explored. They offer considerable insight into the sector.

EQR and AVB represent a total of 152,561 rental apartments. Through NMHC, institutional investors obtain a wealth of quality benchmarked performance information that firmly establishes the asset class in the market.

What might this BtR supply model look like for renters?

There is a substantial body of reputable published material that points to a better deal for renters. These include customer-focused rental REITs delivering tenure certainty, responsive maintenance and security services while some help with relocation from city to city. For most renters, these properties offer a desired lifestyle near to where they work and where they want to socialise. In the US, the NMHC and its members advocate as much for renters as they do for investors. Professional providers normally offer far more benefits and certainty than smaller less able alternates.

Renters should look forward to equitable treatment by their apartment provider. But this becomes a two-way relationship – good provider (host) and good renter. Both benefit from easily observable information about the performance and behaviour of the other. Some providers offer incentives or rebates to long-term renters in good standing to celebrate lease extension or to assist with their eventual move to ownership if they so choose. These relationship arrangements benefit other renters as much as each renter.

There will be a chorus in Australia claiming this situation is akin to their being a “black book” for lousy renters. So be it. The reality is that today’s social media channels already achieve this. A relevant case is Airbnb. The parties submit to referencing of host and guest alike. Most importantly, Airbnb perhaps offers the world’s best dispute resolution platform. This could translate to BtR.

In the case of the BtR model described in this article a renter paying an average rent of $700 a week would pay $36,400 a year. Assuming this might be a two-bedroom apartment with a single bathroom a range of renter options exist. In the US, the 2015 NMHC report on apartment user ages and types is helpful. Singles and couples are understandably the prime users of BtR.

BtR apartments located near where renters work and prefer to live seem to be an inevitable part of futures urban lifestyles. If these apartments provide quality amenities, are professionally managed and offer renewable tenure to renters, they will be a game-changer. It would seem their time has come.

The housing affordability conversation has been dominated by advocates of the neediest. Clearly this is an important social, political and funding imperative. Often, however, this tension includes key workers. In this advocacy, there is less emphasis on making housing achievable for those on another important trajectory. In the end society would seem better off when as many as can, ultimately, achieve housing self-sufficiency. This may include long-term rental or home ownership.

Government and private sector employers will increasingly find it difficult to attract and retain their future workforces if they ignore access to suitable nearby housing.

Governments and industry know that to attract new investment, innovative, creative and skilled workers are key to future economic viability and social cohesion. Housing them is fundamental. They know this enables communities to stay engaged with opportunity and avoid disenfranchisement.

Why government must not miss this opportunity to grasp BtR

Governments are not good at being at the coalface of managing assets and delivering related services. Government is best ensuring the right policies and opportunities are created to enable community infrastructure such as a BtR asset class to start-up and thrive. Governments must understand that the levers to enable a sustainable investment in BtR will involve establishing confidence that the sector’s investment criteria are understood. They must play a consistent national role in dealing with land access priority, uniform taxes, uniform tenancy legislation, concessions and preparedness to stand up to the industry should it under-delivers on promises.

That said, BtR should become a strategically important contributor to the future housing landscape. For the next 10 to 20 years it would not be unreasonable to target BtR delivering 15 per cent of all new density apartment developments. A resolve of this nature will give investors’ confidence to invest and consistently deliver a critical through-the-cycle supply.

Importantly, BtR could offer governments more flexibility in the way they intervene in the market and pursue best value-for-money supply options. Table 1 looks at the rental subsidy gaps to support renters not exceeding 30 per cent of their income spend on housing. This table is for contextual purpose only. Its intent is to make the case for a new set of value-for-money comparators.

BtR should enable government to more accountably consider the total cost to taxpayers of alternative supply interventions (including their overheads). Having as many households as possible able to access a mainstream rental supply offers many prospective dividends when renters are plugged into regular work and social networks. In the US rental market, it is unlawful for rental providers to disclose supported renters, the amount of the support or to treat good renters differently.

Employers should not overlook the ability to help subsidise worker rental if they want to attract and retain the best people. Again, a similar value-for-money equation for the private sector is on the table that can be used to offset the costs of recurring search, churn and training. The numbers in Table 1 look modest.

Governments could co-invest with employers in BtR as a way of equalising imbalances with the cottage rental market by sheltering these rental subsidies as tax-free. Prospective BtR investors should collaborate as they do in the US NMHC to push for pre-competitive resolution of the barriers to establishing this asset class in Australia. They would do well to adopt the best-practice benchmarking adopted by NMHC to make the establishment of a BtR asset class credible and attractive.

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.

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