[+] Numbers Don’t Stack Up for Sydney Build-to-Rent

There are hopes build-to-rent has the potential to increase the supply of residential accommodation in the Sydney CBD.

But experts say at the moment, the numbers don’t stack up to make this work from an investment perspective.

Nevertheless, if various levels of government come to the party this could still be a viable option for partially solving the housing supply problem.

Recent moves by the NSW government, such as the 50 per cent land tax concession, make it appear build-to-rent has the authorities’ imprimatur, while the recent approval of Canada’s Oxford Properties’ 39-storey built-to-rent development on Pitt Street also seems to demonstrate appetite for this type of development.

So what’s the future for this relatively new asset class in the centre of our largest city? This is the second in a two-part series that explores the potential for residential accommodation in the metropolis.

“Federal and state governments and councils are aware of built-to-rent’s potential in alleviating housing supply issues, particularly in CBD, fringe CBD and metro areas, or any other areas where supply is limited,” Diaswati Mardiasmo, chief economist of PRD Real Estate, said.

Tax breaks introduced by the NSW government during the past year, including the 50 per cent land tax concession out to 2040, and the foreign investor duty tax surcharge exemption, may also support more build-to-rent developments.

Removal of the purchaser duty surcharge and land tax surcharge for built-to-rent projects also work in their favour.

Changes to zoning rules is also to build-to-rent’s advantage.

These include amendments introduced in February this year by the NSW government that mean built-to-rent can be built anywhere residential flat buildings are permitted, as well as in the B3 commercial core, B4 mixed-use zones and B8 metropolitan zones.

Favourable car parking rates and a commitment by authorities to support a flexible application of the apartment design guide also bode well for these developments.

Addressing the drawbacks

While there are positives to support more built-to-rent in Sydney, there are also significant hurdles to overcome.

Availability of large, good-quality blocks with residential zoning or buildings suitable to be converted where changing the zoning is also a possibility are other potential handbrakes.

With fewer opportunities for large parcels of land in the heart of the city, it seems more likely build-to-rent developments will go up on the city fringes, or in suburbs within a 10km radius of the CBD that are already popular with renters, such as Ashfield, Chatswood and Randwick.

The cost benefit trade-off is another problem. Mardiasmo notes built-to-rent can be more expensive to build compared to a build-to-sell properties, due to the volume of apartments and amenities required to achieve the requisite lifestyle and community feel.

“Developers also have to take into account maintenance costs post construction, as more often than not the developers become the property managers,” Mardiasmo said.

“It is an extremely exciting asset class. But the economics need to make sense as built-to-rent is a long term commitment of up to 15 years.”

Ian Ugarte, co-founder of property development firm Small is the New Big, says fire and safety concerns are another challenge.

“It’s likely an extensive upgrade would be required to convert a commercial building to a residential building that complies with fire and safety ratings,” he said.

Mirvac Liv Build-to-Rent
▲ Liv Indigo, Mirvac's first build-to-rent complex in Sydney's Olympic Park.

Ugarte says car parking requirements also needed to be taken into account.

“The number of car spaces required in a commercial building is far less than the number required in a residential building,” he said.

“The six spaces required for a commercial floor of approximately 400sq m to 500sq m would almost double to 10 car spaces in a residential building with the equivalent space representing between seven to 10 apartments.”

As with virtually anything to do with building and construction, there are a myriad other potential snags.

Bureaucratic red tape, public objections and the federal government’s withholding tax regime for managed investment trusts—which may tax developments at a rate of 30 per cent, double that of other commercial projects—are other drawbacks.

Looking on the bright side

Objections aside, build-to-rent rather than build-to-sell is one of the big hopes for the future for residential in the Sydney CBD, according to a number of powerful industry voices.

“We want to make sure the city is open to build-to-rent developments because the beauty of build-to-rent is equity stays with one owner, which suits a central CBD context,” the Property Council’s NSW executive director, Jane Fitzgerald, said.

“The problem with strata is if you have a residential building in the middle of the city with a hundred owners, turning it back into an office building down the track might mean knocking it down and rebuilding it.

“Changing it over is all but impossible because you have to convince at least three quarters of the people in the building that's a good idea.

“With build-to-rent, changing it is much more straightforward down the track.”

Urban Taskforce CEO Tom Forrest had a similar perspective.

“Build-to-rent means you have a single owner for a longer period of time,” he said.

“The City of Sydney has worked with the NSW government to deliver positive outcomes for Oxford Properties and for the Catholic archdiocese across the southern end of the city, where there’s a preference for residential, rather than at the Circular Quay end of the city.

“But we think they need to look flexibly at all the options so we’re not looking at holes in the ground if there’s a recession.”

Making the numbers work

Palatable investor returns also have to be taken into account to get build-to-rent properties off the ground.

Binuo Erth, managing partner at Vellum Funds Management, agreed current market dynamics could also stymie the potential for build-to-rent.

The fund manager has raised capital to invest in build-to-rent developments.

“Recovering from the pandemic continues to be challenging and most investors, including developers, have no choice but to prioritise short-term returns so they can survive,” he said.

“While some may be more resilient than others, it is ultimately responsible investors with long-term views that will take the lead on built-to-rent.

“Policy support is instrumental, especially in attracting more local and foreign investment.”

The managing director of real estate consultants EG Advisory and an adjunct professor of engineering at the University of NSW Shane Geha said return on investment was the main problem facing build-to-rent.

▲ Build-to-rent apartment blocks are built specifically to be rented, and held in single ownership to generate long-term income.
▲ Build-to-rent apartment blocks are built specifically to be rented, and held in single ownership to generate long-term income.

“You need compound average rental returns in the high single or low double digits to generate investment-grade returns for institutions,” he said.

“That’s currently impossible.

“The state government could give the land for free to a private developer and stipulate a 30-year rental period for the developer, after which the property would be returned to the taxpayer in a maintained condition.

“Governments could stipulate no sales within the building within 20 years or a set rate of rental return.

“But ultimately, build-to-rent is not appealing because after maintenance costs, taxes and property management fees, the returns are about 2 per cent a year.

“Build-to-rent in the Sydney CBD will only succeed if the land is free, the taxes are removed or rental returns increase to say 6 per cent of total development costs.

“None of these factors appear likely.

“The government holds the strings to this marionette and it can make the puppet dance if it wants. Is there the will to do it? Time will tell.”

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Article originally posted at: https://www.theurbandeveloper.com/articles/build-to-rent-investment-sydney-development