Build To Rent - Key considerations for developers
Build To Rent (BTR) is rapidly gaining momentum across Australia. Internationally, particularly in the US and the UK, the concept has been around for some time and has proven to be a successful investment option for developers.
Here in Victoria, the Victorian State Government recently pulled some of the necessary levers on tax concessions and planning reforms needed to support this emerging asset class.
What is BTR?
In BTR projects, the developer retains ownership of the asset and offers leases to residential tenants. Essentially, the developer manages residential communities, which are often in sought-after locations close to amenities, while generating revenue from leasing the asset.
The BTR model creates greater options for renters and is aimed at responding to the demand for greater choice of high-quality rental housing.
Whilst it is not suitable for all developers, particularly as yields can be lower than other revenue streams, it is rapidly becoming a more attractive investment option in Victoria. There are a number of factors that developers will need to consider before pursuing this style of development.
Benefits for developers
Traditionally, BTR investments were viewed by developers as less attractive than other investment options, principally because of the various tax implications of retaining ownership of the asset over an extended period of time.
In response to these concerns and to support this emerging asset class, the Victorian government has announced, as part of the 2020/21 budget, various tax concessions. From 1 January 2022, eligible BTR developments will be granted:
- a 50% land tax discount until 1 January 2040
- an exemption from the absentee owner land tax surcharge over the same period.
The concessions were announced as part of Victoria’s Big Housing Build and while the concessions will have various benefits for developers (including effectively reducing a developer’s holding costs), they do not necessarily mean that BTR is an affordable housing option for renters. In many cases, these developments are perceived as being premium products.
There is currently no draft bill on the concessions. We will continue to watch this space and provide an update when we know more.
Key considerations for developers
Given the bespoke nature of BTR projects, developers should acknowledge the differences to existing build-to-sell models and tackle the unique issues of BTR ahead of time. Key considerations for developers are:
Acquiring the right site for a BTR project can be similar to any other site acquisition, such as brownfield or infill – however, there are additional considerations pre-acquisition such as complex GST advice on structuring (including margin scheme), holding costs, duty mitigation, planning constraints and alternative finance arrangements.
2. Asset management
Given BTR is a long term asset hold (generating revenue from renting), developers will need to consider the long term management of the asset. This includes leasing the project units and management, repair and maintenance of the units, common areas and amenities.
Developers will need to consider the preparation of property management agreements, letting agreements, operator agreements, maintenance contracts and template leases. Owners corporation structuring and preparation of suitable rules may also be relevant where the BTR component is part of a larger complex which may include other components such as commercial, retail or hotel.
Any BTR structure will need to support the interests of occupiers whilst generating income and delivering value to the developer and investors.
Given the emerging nature of the BTR asset class in Australia, lenders are likely to take a conservative approach to their key covenant package (including loan to value ratios, Liquidity coverage ratios and interest cover). Weighted average lease expiry becomes a key metric, rates and fees may be higher than traditional construction financing and there will be longer lead times to reach drawdown. In addition, lenders will be focused on areas such as the reputation and performance of the leasing manager, whether to fund both construction phase and operations phase and mandatory scheduled repayments during the life of the loan.
The class of lenders in the BTR space will also be different to traditional construction finance due to the lower yields. Experiences so far have shown that finance has initially been through superannuation funds, JV partners or internal loans sourced through corporate or umbrella style financings. However, banks and private lenders are also starting to offer funding for BTR projects.
4. Tax and structure
Structuring a BTR development requires a detailed understanding of the tax implications of a BTR model, which can be significantly different to a traditional build-to-sell model.
Developers need to consider the higher GST costs to be factored into any feasibility modelling, as GST will not be able to be claimed on build costs or other ongoing costs of the BTR development (noting that GST will not however apply to rental receipts). The structure of a BTR fund will need to take into account the extent of any foreign investment and issues with being able to claim the 15% concessional rate on managed investment trust returns.
Given the asset will be held long term and purpose built for renting, the initial build cost of common areas and amenities may be higher. Developers will expect the build standard to reduce ongoing capital repair and operational costs.
Developers need to carefully consider the terms of the various works contracts and remediation contracts. The engagement of consultants is an important factor and developers will need to ensure that construction liability unique to a BTR asset sits with the contractors and consultants.
Developers will also need to consider any ancillary documents, such as the impact of third party agreements, financing documentation, environmental obligations and other bespoke elements that are applicable to the BTR project to ensure any obligations under those agreements are passed through to the construction related documents.
The BTR model is gaining traction in Victoria and whilst this may not be the ‘right fit’ for all developers, it is rapidly becoming a more attractive investment option in Victoria.
The Victorian government’s announcement of various tax concessions has been welcomed by developers and while the concessions will have various benefits for developers, they do not necessarily mean that BTR is an affordable housing option for the renters themselves.
When considering this model, it is important that developers acknowledge and give thought to the differences to existing build-to-sell models and tackle the unique issues of BTR ahead of time. These factors include:
- matters associated with the acquisition phase, including GST on structuring, holding costs, duty mitigation, planning constraints and alternative finance arrangements
- long term management of the asset – including leasing the project units and management, repair and maintenance of the units, common areas and amenities
- finance considerations, including the approach lenders are likely to take
- tax implications
- construction aspects, particularly given that the initial build cost of common areas and amenities may be higher.
We expect to see the BTR model continue to be an avenue increasingly pursued by developers as a successful long-term investment option.
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