Private rental market has been unable to supply affordable rental housing to a majority of low- and middle-income households in Victoria. Rising rents and declining rental services have further extenuated the situation. This opens enormous opportunity for build-to-rent (BTR).
In our Urban densification through private land assembling in inner and middle suburbs for decentralised BTR development research, we examined the potential of BTR to provide affordable rental housing. A detailed financial feasibility model was developed to examine various levers that can be used to improve financial viability of BTRs in general and affordable BTRs in particular.
The project IRR from a BTR project is low. Including affordable component will further reduce the return for an investor. This research analysed four types of levers and their impact on financial feasibility for a BTR project. These relate to revenue maximization, cost reduction, fiscal and planning incentives.
The results indicate that the unit-mix in a project affects returns. In case of Docklands, the hypothetical project analysed in this research, project IRR with 3-bed units is the highest followed by studios. From marketability point of view a mix of different units is desired in a BTR project, however, in terms of share of a type of unit in lettable area, studios and 3-bed seems to generate higher revenue and hence could claim a larger share.
Other mechanisms to increase revenue such as an increase in FAR by 25%, reduction in size of each unit by 10% and increase in building efficiency from 70% to 80%, also increase the project IRR in comparison to the base case.
Reducing land cost could also improve project IRR.
Land cost reduction and land lease generate almost similar outcomes. Ways to reduce land cost could be through zoning land for BTR use, which will reduce competition from BTS developers or through mechanisms such as joint venture with landowners. Land lease is an established mechanism for transferring the use rights of public land and the land owned by not-for-profit entities but is not widely prevalent. There is a case to use land lease structure in case of BTRs by involving public and private landowners.
Exemption on income, land tax and rates (similar to CHPs) can result in higher IRR but due to complexities in tax structures involved market participants are less keen on this option. Full GST refund results in similar IRR as exemption on income, land tax and rates would offer. This is also demanded by industry.
The research also examined the levers that can build affordable housing component in a BTR project. The biggest gain in number of affordable units in a BTR project is achieved with land leasing or land cost reduction models followed by treatment of GST liability similar to BTS developers. Other tax benefits do help but are not that strong a lever to be a game changer. The study identified eight strategies for bringing passive land into active use for a BTR housing development, mainly through a leasehold model (as opposed to land sale).
These include Land assembly through doorknocking, providing service incentives to landowners willing to develop land for rental housing, providing zoning and density incentives to landowners, a land trust model of converting passive land into active use, a combination of the land trust and zoning incentives, using unused air-rights to develop BTR housing, demarcation of growth areas conducive for BTR housing development as a catalyst to land market, rezoning land under obsolete/unproductive uses into ‘BTR residential zones’.
Although most of these strategies focus on bringing private land to use, their application to public land is equally applicable in most cases. Finally, the research examined criteria for selection of an infill and greenfield site for a BTR housing project. Six criteria emerge important. These include buoyant housing market conditions in the suburb, conducive user characteristics (suburb level), conducive investors’ characteristics, housing demand and supply conditions in the suburb, planning and zoning regulations applicable on the site, and tax environment in the market. Careful consideration of these factors can facilitate the identification of suburbs suitable for a BTR housing project.
Today’s housing affordability landscape
Affordable housing is a distant dream to households in the lower two income quintiles (40% of households), single parent with children, lone person households and those below 25 years of age.
Affordable housing is housing that is appropriate for the needs of a range of very low to moderate income households, and priced (whether purchased or rented) so that these households are able to meet their other essential basic living costs.
The other major shift in housing market is related to tenurial preference. More Victorians are choosing to rent houses now than at the beginning of the century. 27.5% of households live in private rental housing in 2016 (Commissioner of Residential Tenancies, 2020). 85.4% of households were renting in private market and the rest were renting in social rental housing (ibid). The share of rental tenure in 2021 (including social renting, the number of which have not increased) further increased to 28.5% (ABS, 2022).
The median rent has increased by 15 percent during 2015-21 and the growth has been faster in regional Victoria. Rents had plateaued in Melbourne during 2020-21. The current market evidence, however, points to a sharp increase in rents in Melbourne (Homes Victoria, 2022). There is a regional pattern to the growth in rents. The trends suggest that the level of median rent is higher in inner Melbourne, inner eastern and southern Melbourne. These regions also witnessed significant rent growth until 2019 but were affected negatively during the pandemic. Median rents in other regions continued to grow or plateaued.
For Public Housing Renewal Program, Homes Victoria defines affordable housing where rent is capped at 75% of market rent. A large proportion of these households are not only crowded out from the ownership housing market but many of them face rental stress. While growth in median rent is less than the growth in median household income during the same period (24% during 2015-21) (ABS, 2022), renting in private market is still stressful for a majority of low- and middle-income households living in Greater city of Melbourne.
The private housing market has been unable to respond to the growing demand for affordable housing. Given the limited supply of social and public housing and the focus of private rental market on middle- and high-income tenants, supply of affordable rental housing is a gap that requires attention and policy focus.
The policies between 1945 and mid-1990s, discussed by Yates (2013), have led to residualisation, financial infeasibility and consequential undersupply of affordable rental housing in Australia. Current private rental housing market is disorganized. Most of the suppliers of private rental housing in Victoria are small landlords who own one (71.8%) or two (18.7%) properties (Commissioner of Residential Tenancies, 2020).
Two-third of private rental properties were rented through a real estate agent. Length of tenancies are short and ‘no-fault’ evictions are common. In 2019, about 2700 ‘no-fault’ eviction applications were made to Victorian Civil and Administrative Tribunal (VCAT). About 15,800 ‘at-fault’ eviction applications were made to VCAT in 2019 and the reason for 96% of ‘at-fault’ eviction notice was non-payment of rent.
Expecting private rental housing market in its current form to address affordable rental housing requirements of low- and medium-income households will be ambitious due to the disaggregated nature of ownership of rental housing stock. Experience of a market based mechanism that was introduced in 2008 through National Rental Affordability Scheme (NRAS) reveals that it is possible to combine various sources of finance (public and private) to deliver affordable housing.
NRAS was the supply side intervention with contribution from Australian Government either as a tax offset or cash, and contributions from state and territory government, which was either a direct payment or a payment in kind. The scheme was discontinued in 2018.
Build-to-Rent in detail
In the last five years, another residential asset class termed as Build-to-Rent has emerged in Australia. Build-to-rent (BTR) is a term that is interchangeably used with multifamily housing. RICS defines five characteristics of BTR: density (at least 50 self-contained dwellings), ownership structure (dwellings are separately let but held in unified ownership), management under single entity with potentially onsite presence, facilities (building is designed for rent purposes and may include amenities) and timeframe (short term assured tenancies).
JLL positions BTR as a product that provides investors investment grade investment opportunities, available for rent and is attractive for those in younger demographics (JLL, 2020). There are around 11,000 BTR units constructed/under-construction in Victoria. Currently BTR is being marketed as a luxury product through a combination of amenities and services, distinct from what the private rental market offers. As a rental housing product owned and operated by large investors has the potential to supply large stock of rental housing units on a long lease basis.
The question, however, remains to be examined is whether BTR can be a financially viable for investors/developers as affordable rental housing product. BTR projects have generally been located at inner city locations, where the availability of large contiguous parcel of land is limited. Moreover, available brownfield land parcels do not share similar risk (contamination, difficult sites to build, stigma, different land uses around them) and reward (well connected by transport infrastructure, amenities).
Can decentralised BTR model which can use disparate land locations and be managed centrally to provide economies of scale, would open opportunities for the expansion of BTR in inner and middle suburbs where rental housing demand is high?
This research undertakes a detailed discounted cash flow model to analyse single/multi-use BTR development options for a hypothetical inner-city project in Victoria. The assumptions and assumed location of the project are representative of projects that are currently underway. Besides conventional housing BTR models, mixed-use models to maximize and diversify revenue and exploit the central location of the land have also been examined.
Various levers (cost, revenue, fiscal and planning) have been analysed to see their impact on financial viability. This provides guidance to policy makers on which levers would be more effective in facilitating the use of BTR for affordable rental housing. An important finding from the research is that strategies that can reduce the cost of land in total project cost would be most important for enhancing financial viability. This research identifies strategies of private assembling of land in inner and middle suburbs of Greater Melbourne that could bring developable land parcels in the market.
It also provides importance evidence to assist developers and investors in evaluating risks and rewards associated with BTR development in inner city locations. Various statutory and planning levers and their impact in feasibility of BTR, particularly for affordable BTRs, provide case for instituting planning reforms.
Additionally, there is growing evidence of private land assembling from across the globe and a Melbourne contextual recommendation for land assembly proposed in this research may be useful for policymakers. An important contribution of the research is to the debate on the contribution that the BTRs can make to the development of long-term rental stock and better utilization of inner and middle suburb lands.
The findings are highly relevant for members of API who are engaged in valuation of these asset classes and those engaged in advisory roles by developers and investors for due diligence.
This research was funded by the Australian Property Research and Education Fund (APREF).
