Why are so many people now looking at Build-to-Rent?
At the end of October, RICS invited me to speak at their NSW CPD event about Build-to-Rent (BTR). I had noted an increased discussion around BTR in both the lead up to the event and since. Whether it’s conversations with landowners, the agency community, or debt and equity providers, there is interest in BTR opportunities from different industry players throughout the region.
Given the disruption to property markets brought about by Covid, it’s no surprise that “Plan B” solutions for residential projects are being sought and alternative asset classes are being considered by both debt and equity funds. The weight of capital looking for a home in our key markets has not disappeared because of Covid. As markets shift and evolve, so must the strategy of its participants.
Build-to-Rent is not a fad that will pass when normality returns, but a sector that will continue to strengthen and grow post-Covid. Landowners, developers, and funders should be alert to opportunities BTR presents now and in the future.
Depth of the Rental Market
According to ABS, in FY17/18, 32% of Australian households rented their home, marking a 30% increase from FY15/16. In Greater Melbourne, 31% rented whilst 36% rented in Greater Sydney.
In recent months, headlines have reported falling rents and increasing vacancies, which has undoubtedly been the case in Sydney’s central areas. It’s important to understand that this is a temporary disruption to the market and not a structural change. Once interstate travel resumes, the short-term letting stock that was dumped into the long-term letting market will be withdrawn (to a point). Once the international students (who have no desire to live in PBSA) return, they will be back in the market looking for accommodation. Once there is increased footfall in the CBDs, the bars and restaurants servicing the business community will need to employ more staff. The recent impact on the rental market suggests workers in these sectors live near their jobs and therefore when those jobs come back, so will rental demand.
CoreLogic’s November indices report, which showed a national annual dwelling price growth of 3.1% (3.7% in Sydney), will likely be a disheartening read for aspiring homeowners. The recent announcement of changes to Stamp Duty in NSW will initially fuel further price growth as buyers who have already made an allowance for Stamp Duty now find themselves with an increased purchase budget.
Rental demand has strengthened in recent years as many have been unable/unwilling to buy property. It’s also likely that migration levels will track back towards pre-Covid levels, creating sufficient and sustainable depth for institutional investment in the residential sector, especially in state capitals.
Development Risk and Return
By incorporating BTR, developers can take advantage of opportunities to secure their project’s future success by underpinning cashflows and de-risking delivery. Be it a full or partial site sale, a forward commitment, forward fund, or even sale of existing stock, pre-determined profit can be assured early in the development process. Equity and profit can be accessed earlier than a typical Build-to-Sell (BTS) project. Whilst BTS may generate a higher absolute profit (over time), BTR provides a risk-adjusted return where the market risk, financial risk, and other uncertainties of residential development can be removed.
For example, consider the costs of land acquisition that must be carried (and capitalized) until refinance or sales income facilitates repayment. This cost could be significantly reduced by exiting sooner in a BTR take-out scenario.
Australian institutions are not strangers to BTR. Many have been exposed to mature overseas markets like Japan, the US, and Northern Europe. Some are also involved in BTR related projects in Australia. However, funds may hold that the nascent domestic sector doesn’t match their risk profile. This was a similar view of many UK pension funds when the sector began, post GFC.
Several of those funds are now front and center in the UK BTR sector, acting as developer, funder, and operator. In some cases, they are even buying sites and taking planned risk. These funds have switched on to residential’s inflation-linked, low volatility, liability-matching income profile. One such fund is Legal and General Investment Management. They reported rent collections across their BTR portfolio in Q2 2020 of 97.6%, significantly ahead of the 80% collected in the commercial sector, according to research by Knight Frank.
BTS projects require a longer lead-in time than BTR (due to the need to secure presales) which can bring supply to market more quickly. In the case of a multi-phase residential or mixed-use project, BTR can accelerate placemaking. Cafés, shops, restaurants, and other amenities can commence trading earlier, which improves the project cashflow and breathes life into the development, acting as a powerful marketing tool for subsequent phases.
At this point in the cycle, securing presales and investor sales are likely to be challenging. Adopting a BTR strategy for even an initial phase ensures development inertia is maintained.
Following NSW’s July announcement that eligible BTR developments will be granted a 50% Land Tax exemption until 2040, the Victorian government has announced a similar exemption in their 2021 budget. Market sentiment is that other states will follow a similar path in due course. Similar moves early on by the UK government regarding taxation, planning, and financial support laid the foundation for the BTR sector to grow to 8% of their commercial property market in less than 10 years.
So, perhaps the question is not “Why are so many people now looking at Build-to-Rent?” but rather, “Why are we not now looking at Build-to-Rent?”
For more info on Build-to-Rent, contact Mark Donnelly at firstname.lastname@example.org.
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