June 2017

A fixed abodeThe opportunity for institutional investors to play a part in improving the private rental market

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If you can’t own a home, you can still make a homeAustralia currently sees one third of its population in the rental market - and this statistic is much higher in our capital cities and amongst younger Australians (for example 70% of 25 to 34 year olds in Sydney rent). Out of this, 40% of overall renters are considered ‘long-term’, holding this status for at least 10 years.

A recent survey of 600 Australians and detailed interviews with 60 long-term renters in Sydney and Melbourne1 found long-term renters in particular frequently expressed regret about not being a home owner – with a mix of Australian cultural (‘Great Aussie Dream’) reasons and logistical reasons.

We may feel as though lots of us are ‘stuck’ in the rental market, but by comparison Australian capital cities have a lower proportion of renters to home owners when compared to other global cities such as London and New York, and much of Europe.

So why is renting in Australia seen as the last resort and something to be done in the short term only? Why does it seem to be the antithesis of the ‘Great Aussie Dream’?

Australia’s weak tenancy laws and the fact that most rental homes are owned by individual investors means that tenure is usually short term, the tenant has very few rights with respect to the aesthetics of the property, inside or out, and under most tenancy contracts the landlord has the power to evict the tenant on 60 days’ notice, without cause.

And so, security of tenancy is compromised for these families and individuals – half of all renters have moved three times and 10 per cent of all renters have moved 11 times.

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New York London

Owner Renter

Sydney Melbourne

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1 Hal Pawson, Kath Hulse & Alan Morris, Interpreting the rise of long-term private renting in a liberal welfare regime context, August 2016

Source: ABS cat. no. 4130 (2013-14), American Housing Survey (2013), APS Annual Population Survey. NOTE: numbers may not add up to 100% due to vacant addresses and seasonal factors.

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This can be a very destabilising situation, particularly for low income private renters in outer suburbs, contrasting the contingent of private renters in the more expensive areas who have made a lifestyle choice that prioritises proximity to jobs, transport, arts, culture and entertainment even at the expense of remaining outside the owner occupier mainstream.

When people are unable to access an appropriate housing choice or live in continual fear of an imminent eviction without cause, or when rent consumes too much of a household income – that is housing stress. Housing stress takes an enormous toll on our cities, communities and ourselves. Even the cost of moving itself (which only attributes to a small proportion of housing stress) is expensive - Australian renters spent $2.4 billion on moving in 2013-14.2

Ben Rooke is a renter in the inner-city Sydney suburb of Potts Point. While he loves his apartment, he doesn’t get too attached. “I’ve moved six times in the last five years,” he laments

“and have just received notice that my current landlord is terminating my lease which will mean move number seven – it feels impossible to settle anywhere.”

Additionally, there is a growing number of households with children in the private rental market (40 per cent of renters now have dependent children3) where the prospect of relocating every 12 months with minimal notice is severely unnerving. This has implications of being forced to remove their children from the local school due to a change in catchment area or logistics. Five and 10 year lease options would allow for the child’s schooling to remain secure, which is vital for the stability of the child and the wider community.

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How many times renters moved in the last five years

Source: ABS cat. no. 4130 (2013-14)

2 Source: ABS cat. no. 4130 (2013-14), IBIS World, Fair Go Finance “Make Moving Happen” survey. NOTE: this includes professional removers, buying or new furniture, van hire, connection fees, end of lease cleaning, storage and transport for pets and family.

3 http://www.smh.com.au/business/property/renting-property-dont-hold-your-breath-for-a-long-lease-20141104-11eftx.html

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The ‘mindset shift’ that needs to happen

In remaining fixated on home ownership, are we holding our gaze on an unattainable goal? Should we accept that a vast number of Australians living in capital cities will be unable to enter home ownership, and adjust the reality from having to own our homes, to being able to make the house that we are living in our home?

We need to shift the conversation to be about a person having access to housing and the ability to make choice in terms of that housing to suit their needs at that stage of life (including an appropriate housing type, level of connectivity and amenity). And, importantly, a person needs to be provided with the stability that enables them to make the house they are living in their home. Even if they don’t own it.

How does our tenure compare internationally?

Australia is fairing very poorly against international rental trends with regard to tenant security. In Germany, indefinite leases are offered, with strict criteria for landlords who wish to terminate the lease. Likewise, the Netherlands will not allow a landlord to terminate a lease without the tenant’s permission and a court order. A twelve month lease is offered initially, after which the option to extend to five or ten years is presented. A similar lease arrangement stands in Ireland, with a six month initial lease, rolling on to a secure six-year lease.4

We do see anomalies in our big cities where, for one reason or another, people live in long-term rental properties. And the effect on their quality of life is stark.

Belinda Sharp lives with her husband and 7-year-old son in the Rocks in Sydney – and she’s lived in the same rental property for 20 years. When interviewed, Belinda relayed how fortunate

4 ABC News, How good is renting in Australia, 16 Feb 2017, http://www.abc.net.au/news/2017-02-16/how-good-is-renting-in-australia/8275520

she feels to be in this situation: “The house is my home. It’s where my heart is and its part of me… It’s the home my son came home to from the hospital and it’s the only home he’s ever known.” Belinda has been able to enrol her child in the local school without the fear of an imminent move, and form a strong network within the local community. However, in reality, Belinda is on a month-to-month lease (and has been for 10 years) and is at the mercy of the standard provision of eviction with 60 days notice without cause. When asked how she’d feel if she had to move: “Devastated,” she replied

“my heart would break.”

Similarly, Paul Alchin and his family have lived in the same property in the Sydney suburb of Naremburn for 23 years. The landlord himself lives in the same street and holds this second property long-term for capital gains purposes. Paul doesn’t think twice when asked the question of whether the property is home: “Of course!” he insists

“We keep the place immaculate as if it were our own. We touch up the paint on the outside, paint bedrooms and decorate – the landlord thinks it’s great because we look after it so well”.

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How can ‘Build to rent’ help?

A strong enabler for security and better conditions of tenure could be to restructure market rental provision through tax concessions and other measures that entice institutional investors to build properties and hold them over the long term for rental – this is known as ‘Build to Rent’ housing (BTR).

Build to Rent is a term first used in the UK to distinguish between traditional Private Rented Sector housing (individual investment properties) and buildings which are constructed for the sole purpose of rental accommodation, owned and operated by a single institution. These developments usually provide both market rent and sub-market rental properties, providing long-term residential tenancies.

A key argument for this strategy is the possibility that superannuation funds, insurance companies, large developers and the like – with the right form of encouragement – would preference long-term rental returns over short-term capital gains and would therefore prioritise long-term tenancies. This will increase the supply of new large-scale housing for long-term rental – driving up overall housing supply as well as provide a wider choice of housing types for those in need.

Additionally, new buildings are able to provide a higher standard of living for those in privately rented homes, with priorities not only on the number of dwellings, but the level of amenity for the residents. Open space, solar access, landscaping, shared services, modern dwellings, community spaces and the location of the community all come into play in the design and delivery of these homes.

What have been the barriers up until now?

In the US, the BTR sector (also called “Multi-family housing”) is the largest real estate class, bigger than commercial and retail property and 25 per cent larger than the Australian real estate investment trust sector. It generates $US163 billion in revenue a year, has more than 500,000 multi-family related companies in the sector, and is estimated to own around $US600 billion of assets.

Feedback from potential investors into Australia have cited red tape and high costs of construction as making Australia too expensive to entice the same level of investment as the US. The US also has much more favourable tax depreciation allowances.

However, change might be possible here in Australia.

Aside from the fact that the housing unaffordability crisis has pushed these issues to the forefront, the global investment environment might be incentivising the mobilisation of a BTR sector. Traditionally, because the yield differential between residential property and retail/commercial property has been too much of a stretch, it’s been difficult for investors to justify forsaking other opportunities for a BTR investment. However, with recent capitalisation rate compression and global wealth chasing investment, the yields in other investments – even commercial property – are starting to become more comparable with BTR.

For developers, this model also mitigates settlement risks and the lumpy nature of build-to-sell. Add to that the bonus of a diversified investment and risk portfolio, and many investors are considering the long-term cash flows associated with BTR a prospect worthy of consideration.

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A new investment asset class

It is nationally accepted that student accommodation is a viable investment asset class. We have seen a surge in the supply of student housing over the last two years, with over 10,000 beds delivered to the market and an expected 40,000 in the next five years.5 And while the BTR model is reflective of the student housing model, challenges arise with introducing a new investment asset class.

In learning from the uptake of BTR developments in the UK, it is evident that owners and funds need to accept a lower development margin than is generally acceptable in the Australian residential development sector. It is therefore projected that investors are likely to be those who already own sites and an established stream of development returns. Additionally, hesitation and risk around establishing management agreements may hinder the uptake of this type of investment.

Institutions, which are often backed by pension and super funds, are showing an interest in the BTR sector, however are considering how to overcome barriers including site suitability, the viability of the land use against other options, the low rental yields and the potentially high construction costs.6 Additionally, there has been, up until now, little incentive by way of funding and financing from the State and Federal Governments.

But the discussion is gaining traction amongst governments at all levels, for example, Treasurer Morrison recently admitted “… attention must also be paid to how rented residential real estate can be better structured to provide more opportunities for institutional involvement.”

How can Government support the growth of this asset class in its infancy? By deploying a range of financial, tax, land and planning mechanisms to bolster viability and investor confidence in BTR.

5 Knight Frank, Build-to-Rent Insight, April 20176 Knight Frank, Build-to-Rent sector set to take off in Australia, 13 April 2017

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Financial and tax incentives for BTR

Potential financial incentives that Government can introduce to entice institutional capital include:

• a contribution to increase viability of the project, such as a direct subsidy to supplement the low-yield, a guarantee to boost creditworthiness or a land contribution at below market value

• tax concessions (eg increased capital gains tax discount for unit trusts investing in build to rent assets)

• a change to Division 6C of the Income Tax Assessment Act 1936 to treat build to rent assets as an eligible investment business in order to attract the 15 per cent tax rate applying to passive investment through managed investment trusts

• addressing features of state property tax regimes that act as a disincentive to institutional investment in build to rent assets.

The planning system and land use incentives for BTR

The complex NSW planning system is fraught with hurdles which may deter investment into the BTR sector. Approval times continue to lag, generating significant costs to developers and uncertainty. With slow progress in the expansion of the NSW complying development process (code assessment), medium and high density residential developments remain outside of this system, placing all applications into the hands of local council as merit-based assessments.

Community resistance to both density increase and sub-market rental housing is a challenge that developers and local councils need to address. We believe that local councils are in a position to better

educate the community in the need for both density uplift and affordable rental accommodation and the benefits these can provide.

With difficulty in obtaining financial incentives, other incentives need to be considered to encourage institutional investment into BTR. We have recently been considering the viability of land use incentives, whereby prohibited land uses (namely multi-dwellings and residential flat buildings) are permitted, provided they include an adequate proportion of affordable rental dwellings.

While we originally proposed that multi-dwelling housing is permitted in the R2 Low Density Residential Zone under this initiative, we have further explored the potential for medium and high density dwellings within business zones, where they are generally prohibited. This provides a two-fold incentive – providing a means to construct a new residential building where the alternative is no build, as well as the added incentive of constructing a non-competing land use within that zone.

The condition for this permissibility would be that the development is constructed entirely as BTR.

With barriers to the planning system and a lack of incentives for BTR developers, it is evident that planning policy needs to begin to proactively plan for this new asset class. We believe this starts with the State Government, commencing with a review of the NSW SEPPs – particularly the Affordable Housing SEPP and the Exempt and Complying Development Codes. This will then need to flow into local Development Control Plans to better-align merit-based assessment priorities.

Build to Rent in the UK – case study

The UK has readily adopted the BTR model, providing large developments of flexible and varied homes at discounted rental rates. They have seen modern, innovative methods of design and construction to build more efficiently, on shorter timeframes and at lower costs, while also attracting a skilled labour force.7 Following a 2012 review of barriers to institutional investment in the private rental sector, the Government established a Private Rented Sector Task Force, overseeing a £1bn Build to Rent Fund. The fund allows for what is essentially a bridging loan, repayable after the home are built and rented out.

The Creekside Wharf development in Greenwich, UK, utilises modular construction for what will provide 249 apartments in two towers. One of these towers will be constructed exclusively for families, with larger floor areas, internal and external play areas, rooftop gardens, pram storage and additional acoustic insulation. A quarter of the homes will be provided at a discount of market rent – 55%, 65% and 75% - in agreement with the London Borough of Greenwich. These dwellings will be interspersed throughout the development to create a diverse, mixed tenure and non-discriminatory environment.

We acknowledge that these levels of rental discount are more widely accepted by developers across the UK, with inclusionary zoning forming part of the mandated planning requirements – and long-term rentals a growing development type. However in Australia, and Sydney in particular, we need to begin to embrace the rental sector (both market and sub-market) in order to provide everyone with access to homes of high amenity, where funding and policy prioritises this form of housing across all levels of Government.

7 Department for Communities and Local Government, Fixing Our Broken Housing Market

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Working together to create great cities

Amy BrownPartner, Infrastructure & Urban Renewal +61 409 388 131amy.a.brown@pwc.com

Ross HamiltonPartner, Real Estate Advisory+61 413 777 447ross.a.hamilton@pwc.com

Stephanie HallUrban Planner, Infrastructure & Urban Renewal+61 (2) 8266 5399stephanie.a.hall@pwc.com

Clara CutajarInfrastructure & Urban Renewal Leader+61 409 223 037clara.cutajar@pwc.com

ContactsWe want the future of Australian cities to be bright. To be places of vibrancy, diversity, productivity, connectivity, quality and inclusion.

Together with community, government and business PwC are committed to shaping our cities for the better. We will help ensure that people have the affordable homes and forms of tenure they need at their various stages of life, as well as opportunities and access to amenities, lifestyle, leisure and jobs.

We are working together to ensure our cities are places that attract talent and investment – where people want to live, work and play.

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