There is increasing media buzz and excitement around build-to-rent (BTR), raising questions as to whether the asset class will live up to the expected hype.
The future success of BTR can be evaluated through five key market factors: demand, innovation, finance, tax and planning. While the market factors of demand, innovation and finance are progressing ahead rapidly, government factors of tax and planning are lagging behind.
Market factors – leading the charge
Demand for the BTR asset class is strong, underpinned by Australia’s solid long-term fundamentals. Population growth has been a driver of house prices across Australia, increasing demand for BTR and changing consumer preferences. Renting is no longer seen as transitional, with an increasing number of consumers happy to rent for the long-term and many opting to never buy a property outright. Affordability is also a key driver as house prices close to work and social amenities are virtually unattainable for most people. As a result, consumer’s expectations regarding rentals have changed. However, people still want their rental property to feel like a home. Consumers are therefore looking to combine the flexibility, choice and convenience of renting with the security of tenure. This is where BTR ticks all the boxes.
Innovation and sustainability
BTR developments are built with future-proofing of the building in mind. Functionality such as moveable walls, multi-purpose/community building spaces, ease of maintenance and the ability to transform spaces are common attributes (e.g. transforming car parks should parking requirements reduce over time).
Technology is also incorporated into the core elements of a BTR design to improve customer experience and better manage and monitor whole of life costs. Maintenance, concierge and community engagement apps are readily available for tenants, while eco-friendly building products and furniture, smart metres, centralised hot water plants, sustainable energy and wastewater management solutions often feature.
This customer and whole of life focus are what sets BTR apart from build-to-sell (BTS) products.
BTR is not strata-titled (unlike BTS) and therefore individual units cannot be carved out for sale. This approach may not be new for banks however, the level of funding that the banks will be comfortable with has yet to be truly tested.
Although domestic investors have shown some appetite for brownfield assets, investment interest in Australia is largely coming from overseas. International investors have a better understanding of the asset class due to the popularity of BTR in the United States and European markets, making them more comfortable with greenfield risk.
That being said, the focus on sustainability as a core element of BTR is helping to attract domestic investors with aligned interests. For example, the Federal Government’s Clean Energy Finance Corporation has recently invested $1 billion in funds to tap into the growing market. Investments such as these are helping to plug the domestic funding gap.
It’s important to note that although BTR will give investors a lower return in general than other asset classes, it should be more stable as occupancy levels tend to remain fairly consistent. The stability of the returns makes BTR attractive to institutional investors with a long-term investment horizon.
Government factors – lagging behind
Potential issues for BTR when it comes to planning include car park and minimum gross floor area (GFA) requirements. BTR products in certain areas may offer opportunities for a reduced number of car parks and/or smaller GFAs per apartment than are typically required for BTS products.
As such, a degree of flexibility in the planning requirements may be required in order for BTR products to properly respond to the demands and preferences of consumers.
Overseas, relaxations in the planning requirements for a BTR project are often linked to the requirement for a certain number of apartments to be offered for rent at a discount to current market rates (i.e. affordable housing). It is possible that similar policy positions may be adopted in Australia, over time.
Key planning related questions that will need to be addressed include:
- Is the current planning regime flexible enough?
- Does BTR need its own planning system?
- Would a one size fits all approach be appropriate?
- Will planning relaxations be linked to affordable housing requirements?
- Would relaxations in certain planning laws result in higher land prices?
Regarding the last point, we note that land tax is a significant concern for commercial property investors. To the extent that relaxations in the planning laws increase the profitability of BTR projects, it will enable developers to bid more for land.
If this leads to an increase in land prices more broadly (as other developers compete for land), it could lead to an increase in land tax for commercial property holders, impacting profits.
There are three main tax concerns when it comes to BTR:
- GST claims
- Foreign owner land tax
- Income treated as residential rental income from a Managed Investment Trust (MIT).
The question for local investors is ‘do I get to claim GST back on a BTR build?’ At the moment, the position of the Government is that there is no GST claim. This causes a cash flow problem for traditional residential developers who are used to receiving GST back on their construction cost. As such, developers who want to venture into the BTR sector will need to think differently about their funding model and funding sources to cover the extra 10% in construction costs.
One way to cover the additional cost would be to contribute more equity into the project.
In recent times, property funds have sourced a substantial amount of capital from non-resident investors. Non-resident investors who invest in MITs that own commercial, industrial, or retail assets have a withholding rate of 15% (for information exchange countries). Unfortunately, however, BTR does not fall into any of the asset classes that will receive this reduced withholding rate.
In addition to increased withholding taxes, if a BTR is developed in Queensland (via an MIT structure) and international investors make up greater than 50% of the investors in the MIT, the fund may be liable for an extra 2% in foreign owner land tax.
Want to learn more about Build-to-Rent?
BDO’s Real Estate and Construction specialists are attuned to the shifting trends affecting the industry. Over the coming weeks, BDO will be providing further insights on the market and government factors impacting the future success of BTR, incorporating insights from developers and other key stakeholders leading the charge in this space.
If you would like to learn more, please contact a member of our team.