Build to rent – Tips to avoid the traps
We outline some of the pitfalls to be avoided, including those around securing funding, understanding the tenant market and incorporating the right amenities and building the right controls into construction documents.
There are no signs of Build to Rent (BTR) slowing in Australia. A very established model in the US and used widely in the UK, BTR in Australia has been subject to a quick and significant uptick driven by the increasing number of Australians priced out of metropolitan housing markets and the tax breaks recently offered by Victorian and New South Wales governments.
What is essential for a successful BTR project is acknowledgement, at the outset, of the differences to existing build to sell models and resolution of some of the issues that are unique to BTR. However, there is no ‘one size fits all’ for BTR in Australia – developers, investors and lenders must determine the drivers and risks that apply to the particular project at hand and navigate them accordingly. Below, we outline some of the pitfalls to be avoided, including those around securing funding, understanding the tenant market and incorporating the right amenities and building the right controls into construction documents. We also recently summarised some key considerations for developers.
1. Failure to understand the tenant market
Understanding the target market is obviously always key in any development. However, it is more so in BTR because:
- the ability to secure funding will often be based on projected tenancies and the performance and reputation of the developer or leasing manager (so there needs to be a thoroughly researched proposition - discussed further in section 3); and
- the attractiveness of the proposition needs to continue well beyond project completion and the initial leasing of the property. How does the building remain attractive to tenants long term?
A deeper understanding of the target market is therefore required. How can you achieve this?
For the Albert Fields in Brunswick, Victoria BTR project, a public engagement project was undertaken by Mirvac and Milieu to better understand the needs and challenges of potential tenants. It involved a survey of 700 people. This highlighted areas of focus including the desire of tenants to personalise their homes and priority of movement for pedestrians and cyclists.
Understanding the tenant market will also help to ensure you incorporate the right amenities. There is a keen awareness that amenities in a BTR model are similar to hotel amenities and are key to attracting the initial tenants, retaining those tenants long term and minimising any downtime between tenants. Like hotel amenities, they can also be an important way of generating additional income for the developer or operator in addition to the standard building management services by offering services within those amenities such as gym classes, swimming classes, spa treatments, car washing, pet grooming, service of food and beverages within bars and lounges etc.
Amenities must be useful for the target market and activated. For example, utilising a rooftop space for sports courts in a multi-family or BTR building may seem cost effective, but if they are not used they are not fulfilling their role. If the design is not thought through it will have long term knock on effects, with managers and operators taking fees to manage assets that are not used or not generating any additional income from the services on offer within the amenities.
Developers should also consider whether the amenities can be used by the BTR residents only or the BTR residents and the general public. The former option means there is a closed market and there is more risk of the amenities and additional services not being used. The latter option means that the amenities may lose their premium status and be less attractive to the residents.
Traditional amenities offered in a buy to sell model will only be part of the picture. The BTR market will demand more. Often the project needs to be tailored to the specific community needs, and create a community atmosphere of its own.
A developer will also need to factor in how the physical amenities can be updated over time. What ‘unique’, ‘new’ or ‘novel’ amenities and benefits can be offered (initially and over time) – ‘green’ construction, car sharing, nannying, internet plans, wellness, ability of tenants to ‘bespoke’ their space.
2. Assuming traditional funding models for residential developments will readily apply to the BTR model
The BTR format, with its focus on treating residents like customers, aiming to deliver attractive community based services and experiences over the long term, gives rise to a number of conceptual and financial hurdles for financiers of traditional build to sell residential developments.
While there have been a few notable Australian financiers who have moved early to raise debt funds to finance (or have otherwise indicated to the market that they have the capacity to fund) BTR developments, many local financiers are not yet ready to deploy funds into this space.
The dependability of proceeds from pre-sold lots and relatively short term facilities that are easily refinanced that typically underpin financing for build to sell residential developments are not available under the BTR model. Rather, a number of financiers we have spoken to feel the BTR landscape in Australia is yet to take shape and there are only a limited number of local examples from which lessons can be drawn.
It is for these reasons, however, that we believe the BTR model will accelerate the evolution of alternative funding models in the Australian market, as participants are keenly observing projects recently funded by offshore banks and providers of long term capital, such as domestic super funds.
Despite the paradigm shift discussed above, we think developers and local financiers who are keen to participate in this sector will find BTR projects that will attract financing, particularly where the developer can demonstrate:
- a successful track record in BTR developments in local or overseas markets or in other co-living, purpose built student accommodation and / or mixed used residential developments in Australia
- it has secured adequate levels of equity funding for the development;
- that the project will scale up, stabilise and perform over the mid to long term over a defined period
- a clear roadmap for the project to become cashflow positive on a predictable basis; and
- that the product will be affordable and highly sustainable, is community-focussed and will offer a high standard of on-sight management services that will encourage customers to reside in the development for longer tenancy periods.
3. Not delineating the roles
Those identifying BTR opportunities need to determine, at the outset, what role they will play in the development and its ongoing operation. There are specialist BTR operators who do not develop or invest in the land involved in the sector, in addition to large diversified property groups and developers who may own, develop and hold and manage the developed assets. The BTR market is specialised – there are advantages in outsourcing services and bringing in third party expertise. However, the fees that need to be paid for this (typically in the form of asset management fees) need to be factored into the initial modelling.
4. Not developing a specialist asset management mindset
In many cases, the asset management phase of the BTR model will be central to the developer’s feasibility for the project.
However, asset management in a BTR model is not straightforward – in some cases high turnover may be predicted, which is why superfunds are interested in BTR. Whilst BTR may offer relatively low yields, the superfunds see BTR as a long term investment which is a reliable and stable income source. It is also why many of the BTR players in the market are investing in or developing multiple BTR projects rather than just the one.
Part of the attractiveness of the offer for tenants is the cost of the asset management services – what may be expected is a premium offering at a value based price point. This assumes the developer will have multiple asset management projects in order to leverage this cost – will that assumption be borne out? As above, volume definitely seems to be key to revenue generation.
This is a consumer facing role – there are expectations as to service levels. If consumers do not have a positive experience this may impact their willingness to rent from the developer in future. Brand loyalty is extremely important to the success of a BTR project.
5. Failing to build additional controls and rights regarding design and construction oversight into the documents
As the entity developing or funding the residential development will retain ownership of the residential development, developers and investors should consider:
- the level of design control it wishes to retain – does the developer or investor wish to retain full design control (in which case it may consider engaging a builder under a “construct only” construction contract) or is it comfortable with engaging a design and construct contractor (in which case, some control may be lost on the final design, though this can be managed through a well-documented Principal’s Project Requirements)? Developers and investors should also consider engaging consultants under formal consultancy agreements to ensure that design risk is appropriately documented;
- any collateral warranties for particular equipment or items – consider asking for prolonged warranties for specialised equipment and items to ensure that the BTR residents get the full benefit of these items in their homes; and
- assessing quality during the construction process – consider requesting samples of products before they are incorporated into the development, requesting that the builder builds a prototype home to assess quality or build a development which is consistent with a benchmark project.
BTR may prove a very successful model for developers, investors and lenders. Certainly, it provides a diversification strategy for superannuation funds and the listed property groups. Supported by government, the market will certainly grow in Australia. However, the majority of Australian projects are in their infancy – whilst there will be learnings from these, planning is critical.
We have also published a flyer on the key BTR considerations and how we can assist here.
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