Build-to-Rent in Australia: The opportunities and challenges of an emerging asset class

The hallmarks of ‘Build-to-Rent’

‘Build-to-Rent’ (BTR) is an alternative residential tenancy model, where units in a complex are purpose built for long-term leases, held cumulatively and continuously by one owner and managed by a single manager.

Although relatively new in Australia, BTR projects are rapidly attracting a new class of investors who are seeking to capitalise on the growing demand for high-quality rental properties with steady yields and a diversified income source.

BTR developments aim principally to increase the supply of rental dwellings, improve the experience of tenants and bolster outcomes for institutional investors. In so doing, BTR presents a fundamental change from the traditional ‘Build-to-Sell’ (BTS) market – a change backed by international experience.

However, in Australia, BTR developments face unique obstacles including high operational costs and a piecemeal regulatory framework. This post outlines some the key opportunities and challenges which exist in this emerging asset class.

A ‘snapshot’ of BTR

BTR projects are renowned for offering a higher-end specification of apartment in a central business district, as compared to BTS equivalents. To attract tenants, the projects include a superior amenity (with, for example, up to 5–6 sqm of amenity per apartment compared with roughly 1 sqm as compared to similar BTS products), with tenants tending to be young professionals (between the ages of 26–40).^[i] It is also common for government policy to incentivise affordable housing facilities within BTR projects, typically for a fixed percentage of the occupancy.

BTR buildings come in many varieties, often incorporating ‘mixed use’ programming with retail and/or office space (including co-work space) as part of the development. BTR projects can also be built within a broader ‘precinct’ which includes public amenity such as green spaces.

The BTR model is well established in the United States and the United Kingdom. (BTR is known as “multi-housing” residences in the United States). From January 2021 to April 2021 alone, more than £1.2 billion was invested in the UK BTR sector.^[ii] By contrast, the Australian sector is only just emerging, but is building pace with the nation’s pipeline of projects expanding by 68% in 2020.^[iii]

Why consider BTR?

BTR developments offer something for all stakeholders:

• For investors and developers, BTR developments offer a low volatility / high stability asset. As these BTR assets are held by investors over a longer term (decades, as opposed to years with a typical BTS asset), they are less sensitive to market volatility. Moreover, BTR projects appear to work counter-cyclically, both in construction and in rental returns.
• For tenants, BTR developments provide high quality, proximate, rental accommodation. Because the success of BTR developments for other stakeholders is linked to long-term tenure, tenants are afforded a high quality place to call home, which appeals to tenants who often report poor experiences with BTS (such as a frustrating landlord friendly system which provides little control and security of tenure for tenants).
• For government, BTR developments can be a conduit to facilitate the government’s affordable and social housing or other policy initiatives. Further, BTR developments are often built to a larger scale than BTS. Such an increase in housing stock generates more cost effective housing options to help address Australia’s housing supply deficit, while providing a much needed boost for the construction industry.

Why Australia is primed for BTR

Australia offers prospective developers fertile ground for BTR projects due to the culmination of two factors.

First, there is a shortage in supply of residential accommodation across Australia’s capital cities. This is often attributed to fluctuating market conditions, lower individual investor yields than alternate asset classes, and difficulties in financing BTS projects.

Secondly, demand for BTR in Australia is growing:

• Shift towards renting: For both lifestyle and affordability reasons, there is an increasing trend amongst Australians towards rental accommodation. Over 32% of Australian households are renting, up from 27% only 20 years ago.^[iv] The so-called “Australian mindset” which views short-term renting as a stepping stone towards home ownership is changing.^[v] Young Australians are increasingly preferring the flexibility and standard of living offered by long-term rental tenancies close to the city.
• COVID-19: Whereas the GFC acted as a precursor to the UK’s interest in BTR, many industry stakeholders suggest that COVID-19 may do the same for Australia. That is because Australia’s (relatively) successful response to the pandemic will increase migration levels, and because lockdowns have shifted perceptions on the kinds of facilities that are desirable for tenants.
• Investors looking to new investment opportunities: Although BTR projects are unlikely to achieve a return that is comparable to other asset classes (retail, office, aged-care), they are a relatively secure investment. Investors have also drawn encouragement from the rapid expansion of purpose-built student accommodation in Australia over the past ten years.

Where are BTR projects going to be in Australia?

BTR developments are located in urban centres (typically 5–7km from the CBD). In the UK they have spread from London to other major cities, such as Birmingham and Manchester. In Australia, most BTR developments (around 65%) are taking place in Melbourne, as Sydney’s land is seen by some as too expensive. The Brisbane market has also been seen to be “gaining momentum”.^[vi]

Hurdles for build-to-rent

There are a range of hurdles that BTR developments face when taking root in the Australian market. They can be divided into two broad categories of ‘Government’ and ‘Investment’.

1.1          Government hurdles

Tax: Australia’s tax laws do not cater for BTR investments:

• GST: While no GST is payable in respect of rental payments, a landlord of a BTR development is unable to claim back GST incurred on third party costs associated with leasing activities (e.g. construction costs, maintenance / operational costs).
• Stamp duty: In most Australian States and Territories, the land tax and stamp duty costs are higher on residential land (which included BTR) in comparison to commercial land.
• Income tax for foreign investors: BTR projects backed by foreign investors would attract much higher income tax costs relative to other real estate assets if they are ineligible for the managed investment trust (MIT) concessional tax rate. At present, an eligible foreign investor (e.g. foreign pension fund or sovereign wealth fund) operating an MIT will be taxed at the ordinary rate of 30%. However, BTR investments that satisfy affordable housing conditions may benefit from a concessional tax rate of 15%.

Planning policy: As yet, planning policy remains uncertain as there are no provisions which deal with BTR projects as a development type.[vii]

1.2          Investment hurdles

There are a range of investment related hurdles inherent to BTR developments, including:

• Relatively low yields: The yield generated by BTR developments is significantly lower than what might be expected from other asset classes. Militating against that concern is that BTR developments are not reliant on anchor tenants for income security.
• Complications for distressed operators: Landlord who face liquidity problems may find it more difficult to dispose of the asset.
• High construction costs: This concern is not unique to BTR projects, but will have an effect upon developments close to central business districts.

Reform

In the UK, the BTR sector initially leveraged off of the government’s support following the Montague Report^[viii] in 2012.

In Australia:

• The New South Wales Government has introduced land tax and stamp duty concessions for BTR projects. This will, amongst other items, reduce the taxable value of land by up to 50% for certain BTR developments, and allow for refunds for both the land tax and stamp duty surcharges for land developed into BTR properties.
• The Victorian Government has similarly to the New South Wales Government included in its 2020/21 budget a 50% land tax discount. Certain BTR developments may also qualify for an absentee owner surcharge exemption and the foreign purchaser additional duty exemption. Observers of the industry will also be particularly interested in the 2021/2022 Victorian State Budget Update, as in last years’ Budget, the Victorian Government confirmed its intention to introduce a 50% land tax discount (and an exemption from the 'absentee owner surcharge') for eligible BTR projects – to take effect from the 2022 land tax year. The requirements to qualify for this exemption are however yet to be announced.
• The Queensland Government has launched a “BTR pilot project” directed at increasing the number of long-term affordable rental properties. Under the pilot project (stage one), Frasers Property and Mirvac will each develop large apartment buildings in Fortitude Valley and Newstead precincts. The government will provide a rental subsidy of 25% for a proportion of the apartments aimed at providing affordable housing. The pilot project was initially targeted at developments on privately owned land (at the cost and risk of the successful proponent) but has now expanded to include an expression of interest on a state-owned sites, including at 50 Quay St, Brisbane City.

Where to from here?

This post provides a brief overview as well as highlighting the emergence of BTR developments in Australia. The asset class, while relatively new, is set to change the residential sector in fundamental ways with the backing of government to clear remaining hurdles, opportunities abound for investors, developers, and tenants alike.

By Jane Hodder, Partner, James Peterson, Senior Associate and Patrick Cross, Solicitor.

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Footnotes:

[i] See Savills, ‘UK Build to rent market update – Q1 2021’ (2021), https://www.savills.co.uk/research_articles/229130/312837-0.

[ii] See Savills, ‘UK Build to rent market update – Q1 2021’ (2021), https://www.savills.co.uk/research_articles/229130/312837-0.

[iii] See CBRE, ‘Built-to-rent Development Pipeline’ (2021) http://cbre.vo.llnwd.net/grgservices/secure/Australian%20Viewpoint_BTR%20Development%20Pipeline%202021.pdf?e=1619564916&h=f56798e8f27f0b881e346f7129bcb93e

[iv] See Development Finance Partners, ‘White Paper: The reality of brining built-to-rent to Australia’ (2018), page 3.

[v] See Colliers International, ‘The Introduction of Build to Rent in Australia’ (2019), page 4 https://www.colliers.com.au/download-research%3FitemId%3D5f412cac-90c1-4f53-8031-8cd69af74f3e+&cd=1&hl=en&ct=clnk&gl=au.

[vi] See CBRE, ‘Built-to-rent Development Pipeline’ (2021) http://cbre.vo.llnwd.net/grgservices/secure/Australian%20Viewpoint_BTR%20Development%20Pipeline%202021.pdf?e=1619564916&h=f56798e8f27f0b881e346f7129bcb93e (page 6).

[vii] See EY, ‘Continuing the build-to-rent conversation in Australia’ (2020) https://www.pwc.com.au/tax-alerts/build-to-rent-conversation-in-australia.html.

[viii] https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/15547/montague_review.pdf.