A very narrow gap between gross rental yields and mortgage interest rates is a buy signal for investors.
What investors can learn from the build-to-rent trend
There is some buzz and excitement around the term build-to-rent at the moment.
A number of developers – not least giants Mirvac and Stockland – have made public comments indicating support, to varying degrees, for the model. It’s an approach that would see developers, either using their own book or on behalf of institutional clients, build residential apartment blocks and then lease individual units to tenants. In short, the developer (or their client, say a superannuation fund) would become a long-term owner of the apartment block and its property manager.
Advocates for build-to-rent believe its time has come. In the past, investing institutions have favoured commercial property over residential property due to the superior yields. But commercial office yields have been falling in recent years such that build-to-rent yields would be at a similar level of around 4.5%. And, of course, gross yields would be higher than the 3% or so older-style properties typically yield.
Moreover, with an oversupply of new apartments seeing a faltering in the traditional build-and-sell model, plus the opportunities to market build-to-rent as part of the answer to falling affordability and possibly earn tax breaks from the government along the way, build-to-rent activists believe they have a good narrative.
For me, what makes this push fascinating is what it reveals about the failing conventional business model that proponents are trying to upend.
The conventional model is of course build-and-sell developments. Or, to be more accurate, sell-and-build, because developers usually sell the units ‘off the plan’ and only start building when enough orders have been received to make the project viable.
Now I have lamented on more than one occasion that this build-and-sell model tends to incentivise developers to under-invest in the integrity of the build quality (because quality is expensive) and over-invest in marketing those properties (as it is relatively cheap). Too often, developers know they just need to include enough ‘bling’ – fancy extras such as European appliances – to sell off the units, leaving the poverty of the designs and workmanship as a problem for the new owners.
Build-to-rent is a serious proposition because the consumer market is becoming increasingly wise to these questionable tactics and developers are fearful of being left with unsold stock.
Clearly a build-it-cheap approach can’t be adopted with the build-to-rent model because, as the ongoing owner – or, if they sell to an institutional client, because of the various warranties they would be beholden to – developers will have to live with what they have built.
If the building doesn’t have the requisite integrity that the market and tenants expect, the developer will suffer low rental yields and high vacancy rates.
It will be interesting to see if Mirvac and other developers can actually make the economics of this model work or, if they can, whether it will only be possible with contributions from the government through its various affordable housing initiatives.
Ultimately this is the developers’ challenge. But for the rest of us, it is also a reminder that the conventional build-and sell business model for new apartments isn’t designed to maximise the interests of the private investor.Richard Wakelin