Housing shortages – is the build-to-rent model the solution?

Introduction 

The housing shortage in Australia is widely publicised. Public and private sectors are aware of the housing crisis, and it’s become a matter of great concern.

How can we address this increase in demand and shortage in supply quickly and efficiently?  A potential solution may exist in the “build to rent” or “multi-family” (BTR) models as an alternative solution to the traditional “build to sell” (BTS) model which has been floated for a number of years.

The challenge for new products like BTR is the lack of a suitable legal and taxation infrastructure to support or incentivise developers and operators to invest in the space, and accessibility to finance.  There has however been progress and we are now seeing more BTR projects in the pipeline of housing stock, with the number of BTR units under construction undergoing planning between now and 2025 reportedly doubling from 2021 to 2022. 

In response to the housing shortage and the perceived challenges with the BTR model, the property industry is witnessing momentum for alternative models in the residential playing field.

The high demand and shortage in supply of residential housing stock is creating exceptional opportunities in the Australian market for experienced BTR investors and developers.

Facts and Figures

Some interesting metrics underpinning the lack of residential housing supply are reportedly:

• the home ownership rate for Australians aged 25–29 was 50% in 1971, this can be compared to 36% in 2021¹. Similarly, the home ownership rate of Australians aged 30–34 was 64% in 1971 and 50% in 2021. There has been a 14% decrease in ownership across the board²;
• in 2021, there were nearly 9.8 million households in Australia of which 31% or 2.9 million households were renters.³ The Rent Affordability Index report published in November 2022⁴ suggests that on the whole, rental affordability in Australia is at an historic low, and demand for rental accommodation has increased significantly since the post-COVID opening of local and international borders; and
• the estimated shortfall of homes needed to house new households will be nearly 165,000 by 2032 and an extra 20,000 dwellings a year need to be built to avoid that housing deficit⁵.

Breaking it Down

These figures tell us that:

• there is a clear need to support and encourage the efficient development of residential housing;
• action is required to ease pressure on housing affordability, both to own and to rent, and to facilitate long-term, sustainable accessibility to housing; and
• opportunities exist for experienced BTR investors and developers to capitalise on the high demand and supply shortage.

The BTR model has, to a certain extent, been utilised to plug the gaps in the high demand and limited supply of available and affordable housing stock.  AUD$3.5 billion has been invested in Australian BTR projects (predominantly located on the Australian eastern seaboard) with 3,800 completed institutional grade BTR units and another 8,400 units under construction. Further, it is currently estimated that an additional 22,500 units are in the pipeline and are currently undergoing planning approval. 

Australian State governments have also begun to recognise the BTR model as a solution to solve the affordable housing gap.  For example, the Queensland State Government has expanded its $2 billion Housing Investment Fund to increase investment in affordable housing.  As part of this initiative, the Queensland State Government has approved three BTR projects.

There are high hopes in the market for what increased investment in BTR projects will do to ease some of the pressure on the housing market by delivering quality, and affordable residential stock to the Australian market. 

BTR – Current Landscape and Potential Challenges

The BTR model remains relatively new in Australia, so much so that there is not at present an Australian jurisdiction that has defined what build to rent is.  This creates a number of challenges for those looking to operate in the BTR space, as it means that the legislative and taxation framework that BTR operates within is not fit for purpose, making efficient project structuring a complex task.

The recent surge in the BTR pipeline is largely attributable to low vacancy rates in residential property and the anticipated shortfall in pipeline in the next few years.  Eliminating some of the continuing barriers to investment in BTR locally is necessary to support the continued growth of the BTR market, and consequently, the supply of additional residential stock to the market.  By doing this, it will make it easier to attract capital, investment by institutional investors (local and foreign) and improve access to finance. 

Perhaps the most pertinent barrier is the consequence of classifying BTR as “residential property”.  Large-scale real estate assets are often conducted through Managed Investment Trusts (MITs), with the predominant users of this structure being non-resident investors.  The main purpose of holding assets in a MIT is to take advantage of a lower tax rate – halved from 30 per cent, to 15 per cent, which is a strong incentive to invest in Australian property.  

However, under the changes introduced by the Treasury Laws Amendment (Making Sure Foreign Investors Pay Their Fair Share of Tax in Australia and Other Measures) Act 2019 (also known as the Stapled Structures Act) income from residential property (other than for affordable housing) is categorised as ‘non-concessional income’ and is taxed at 30 percent. 

The treatment of BTR as residential premises under Australia’s Goods and Services Tax (GST) regime is less favourable than for BTS developments.  Under a BTS developments, a sale to a purchaser of a “new residential premises” (less than five years old) is a GST taxable sale, which allows the developer to claim credits for GST they have paid on development inputs.

However, as leasing residential premises is an “input-taxed” supply, as no GST is levied, no credits may be claimed for GST paid on development inputs.  BTR developers therefore end up absorbing those costs.  If BTR developments were to be instead classified as “commercial residential” developments or had some other similar classification, developers would be able to make a claim for GST paid on development inputs.

Other challenges in the BTR structure, include:

• planning consent issues and a need to educate local planning authorities on BTR to facilitate the approval process. The uncertainty in treatment of BTR applications can act to dissuade investors from pursuing BTR projects as development costs are affected by the certainty of planning approvals.  In Victoria, the Build-to-rent Standing Advisory Committee has been established to address this, with a view to providing a consistent, timely and transparent process for assessing the merits of planning permit applications for BTR developments; and

• the calculation of land tax on the aggregate site value of land is a concern for BTR investors as, unlike with commercial premises, generally these costs cannot be passed on to tenants under residential tenancy laws. Recently land tax concessions have been provided in Victoria and New South Wales.  For example, in Victoria “eligible BTR developments” are entitled to a 50% reduction on the taxable value of the land used for the BTR development for up to 30 years, provided that the development continues to satisfy the eligibility criteria for a continuous period of at least 15 years. 

Alternatives to BTR – the disruptors

The combination of the stress on housing supply, affordability and the perceived challenges with BTR has encouraged innovation by stakeholders in the industry including developers, operators and affordable housing advocates. 

One of the more notable models has been the “build to rent, to buy” model, which was developed by Assemble Communities⁶ with a view of providing quality housing to residents, while providing them with rent stability, transparency on price and importantly, a path to home ownership with an option to buy their apartment at the end of a five-year period.  

Similar to this, is the “lease to own” model, a model which has some popularity with developers overseas, but which has been slow to develop in the Australian market, largely due to concerns with financial services licensing (i.e. a developer cannot itself grant a lease to own arrangement as it has been treated as a financial product).  Regardless, there are lease-to-own products being offered on the market, with an example being the ijara product offered by funders such as Ijara Finance.  This is effectively a Shari’ah compliant alternative to a mortgage whereby the financier acquires the property and rents it to the purchaser/tenant, who has an option to purchase at the end of the ijara/lease term. 

Some other models have focussed on providing access to finance, including through crowd-funding (e.g. CrowdProperty⁷) and “baugruppe” models (e.g. Property Collectives⁸), both of which are delivering successful smaller projects, albeit on a smaller scale than BTR projects so far.     

Thoughts to leave you with

The shortage of housing, escalating rents, rising inflation and the resultant decrease in housing affordability in Australia means that intervention is required imminently. 

A unified national policy approach to BTR or alternative model for the delivery of residential housing stock, even on an interim basis may provide the incentive required to kickstart private investment. This will enable the private sector to deliver quality residential stock, for a return commensurate with other similar real assets.  Together with traditional BTS development and the additional stock created by market innovators, BTR done right has the potential to increase the supply of rental properties, sustainably and address the housing shortage.

Despite the challenges, the high demand for residential housing stock and relative infancy of the BTR model in Australia creates exceptional opportunities for experienced BTR investors and developers looking to capitalise on the high demand for residential housing stock while enjoying the benefits of long-term stable yields without the market saturation risk applicable to build to sell developments.

If you have any questions regarding the content of this article or if you’re interested in exploring these topics further for yourself or your business, please reach out to Sallie Bowtell or Harry Stone.