Altus Group’s President of Cost and Project Management, Niall McSweeney, and Offer Manager Anthony Lisbona recently sat down with James Barlow, Enterprise Account Manager at Altus Group, to share their insights in ‘The Future of Build to Rent in Australia.’
By Niall McSweeney, President, Cost and Project Management, Asia Pacific, and Anthony Lisbona, Product Manger at Altus Group
What is the future of Build to Rent in Australia?
Tight rental markets, interest rates hikes, supply shortfalls and rising net migration are all putting pressure on housing affordability at a time when institutional investors and large developers are looking beyond the traditional asset classes of office and retail. As demand drivers converge, local and international investors are making moves into the Build to Rent sector.
Analysis by EY has found Build to Rent currently accounts for just 0.2% of Australia’s housing stock, but with the right settings, more than 150,000 new Build to Rent homes could come to market over the next decade. In fact, the Australian Government is looking to the nascent asset class to help it hit an ambitious target of 1.2 million new dwellings by 2029. The May 2023 Federal Budget outlined taxation changes to encourage Build to Rent, including a 50% reduction in the withholding tax rate for managed investment trusts. State governments are also offering incentives, including land tax concessions and exemptions from foreign investor land tax surcharges.
“We see this as a very desirable asset class for the delivery partners, for the end owners and for the actual population at large.”
Niall McSweeney, President, Cost and Project Management, Asia Pacific, Altus Group
Altus Group has seen significant interest from clients, both institutional owners and private developers. But moving into Build to Rent is not simply a matter of ‘build it and they will come’.
Breaking down the Build to Rent barriers
Nearly a quarter of poll respondents (24%) noted construction costs and escalation as the biggest obstacle in the way of them starting a Build to Rent project – and this comes as no surprise to Altus Group. Construction is, after all, one of the biggest input costs of any project. But for Build to Rent, costs include not just those incurred upfront, but also during maintenance and refurbishment works.
“Successful Build to Rent requires an operational mindset.”
Niall McSweeney, President, Cost and Project Management, Asia Pacific, Altus Group
Developers cannot simply “rebadge” build-to-sell product. What he called “true Build to Rent” is more akin to running a hotel or student accommodation – which “comes down to the brand” and the resident experience. “The real key is making sure you’re not cutting corners at the beginning and sacrificing the long-term… cleanliness or general maintenance.” Following construction costs, the next biggest barriers were project feasibility (21%) and insufficient returns (14%) – and Anthony had some fascinating insights to share.
Assessing the feasibility of Build to Rent can be broken into two parts, Anthony said. There are the “indirect metrics” like reputation and strength of the brand, which can influence an operator’s ability to attract tenants. Service and responsiveness to maintenance requires can impact the ability to retain tenants.
Direct metrics include all the financial inputs. Because the objective is to hold over a long period, perhaps as long as two decades, there is “a different mindset,” Anthony agreed.
“There is more of a focus on yield, your exposure to interest and debt is a lot longer.”
Anthony Lisbona, Product Manger, Altus Group
Interest coverage and debt servicing ratios are more important, as are tenant turnover costs. Owners must consider how capex and maintenance costs will impact cash flow over time.
Land acquisition costs can make or break feasibility, and the cost of land per unit is a sticking point, the pair said. In Melbourne, land costs account for around 12% of a project, Niall noted, in comparison to 35% in Sydney.
“That really gives you an idea of why we are seeing the emergence of this product class in Victoria rather than New South Wales.”
Niall McSweeney, President, Cost and Project Management, Asia Pacific, Altus Group
Anthony also points out that Build to Rent still faces several other “big blockers” in Australia. One of the obvious ones is the inability of developers to reclaim GST on capital costs. Build to Rent landlords cannot claim back the 10% GST incurred on third party costs associated with leasing activities, construction costs and maintenance.
“Straight away that increases your capex by 10%. You must borrow more money. You can’t reclaim that back from the ATO.”
Anthony Lisbona, Product Manger, Altus Group
Access to capital is another roadblock (and 7% of respondents to Altus Group’s poll noted it was the biggest factor preventing them from moving into the Build to Rent space).
As Build to Rent is an emerging market in Australia “there isn’t much comparable data,” Anthony said.
The National Multifamily Housing Council in the US is a treasure trove of data on demand, construction costs, finance and investment, economic impact, market conditions and more. But Australia is yet to build its arsenal of data and banks are still “hesitant” to lend “when developers don’t have any runs on the board”. As such, private developers must look further afield to alternative sources of funding, like a debt fund.
“But even then, some of those debt funds will have certain sustainability targets they’ll have to achieve as well. So, it’s not simple.”
Anthony Lisbona, Product Manger, Altus Group
Technology can also be an impediment, as most off-the-shelf systems aren’t suitable to the Australian market. While some Build to Rent operators can integrate “best of breed” technology, others are having to build technology solutions “from the ground up” – and this can come at a considerable cost.
Of those polled by Altus Group, 11% noted lack of skills as a barrier to Build to Rent in Australia. Developers are on the hunt for the best people, Anthony said, and are having to lean on other sectors, like student accommodation or co-living. This isn’t simply a delivery problem – it also influences the ability of developers to assess opportunities at the feasibility stage. Many developers are having to outsource their analysis, “and this slows down the process”.
Planning and approvals presented the biggest barrier for 7% of those polled by Altus Group. “Layers of approvals” adds extra time to the schedule, Niall added.
“Time is now the big thing that is really hurting feasibilities because the holding costs are too much… and that is eating away at that very narrow margin.”
Niall McSweeney, President, Cost and Project Management, Asia Pacific, Altus Group
Forecasting the future
Organic growth will, with time, alleviate some of the current inhibitors. Others, such as GST, are in the hands of governments. But one of the biggest accelerators will be the imperative to upgrade older commercial stock, Niall observed. Increasing pressure on valuations and vacancies is tempting some developers towards adaptive reuse. The national vacancy rate stands at 12.8% in CBD markets, and 17.3% outside CBDs – but zoom in on lower-grade stock and “we are seeing 30% or 40% vacancy” in some markets. “Build to Rent is an obvious solution,” especially for offices in city centres, near public transport or social infrastructure.
The upside of adaptive reuse is speed to market – provided the feasibility stacks up – “because then you are looking at repositioning rather than a total knock down and rebuild”. Build to Rent can alleviate the waiting game because there is a single entity, and the asset is “generally held in one stratum”. And with its emphasis on “repetition and standardisation”, Build to Rent can deliver cost savings during construction, as well as more opportunities for “off-the-shelf” repair options.
What will Australia’s Build to Rent models of the future look like?
Anthony pointed to the Assemble Futures build-rent-buy model – “a different take on Build to Rent” that provides an “alternative pathway to ownership”. Other developers are embracing a “hybrid strategy” with part buy-to-sell and part Build to Rent to minimise their exposure to risk.
In Germany and Scandinavian countries, renters of Build to Rent apartments choose an “empty shell” that they fit out to suit their own needs – down to the flatpack kitchen. That may be a bridge too far for Australia’s market, Niall noted. Perhaps the UK model, where adjoining units can be connected and reconfigured as residents’ needs change, will be more palatable to Australians.
“It’s a bit like the dual key scenario you see in some serviced apartments.”
Niall McSweeney, President, Cost and Project Management, Asia Pacific, Altus Group
When thinking about Build to Rent, many complex and competing challenges come into play. But Altus Group’s experts offered a clear message to the webinar audience: Don’t think about what is happening now.
“Rental vacancy rates, levels of supply or competition in the market today are meaningless.”
Anthony Lisbona, Product Manger, Altus Group
What will the vacancy rates look like in a decade’s time? What supply is coming online? How will the infrastructure in the area evolve over time? These are the questions that can help Australian developers determine whether Build to Rent is part of their future.
