Australia aims to ramp up the supply of residential rentals to help meet chronic housing undersupply. This is largely an untested residential segment for the country, whose housing market is dominated by owner-occupied dwellings.

S&P Global Ratings does not expect Australia's build-to-rent (BTR) initiative will roll out in as sweeping a way as government targets would imply. We do, however, think over time BTR could relieve housing pressure and expand the spectrum of housing on offer to tenants.

At this stage, Australia's BTR sector does not enjoy the same maturity as the multifamily/apartment sector in the U.S. Consequently, equity investors remain apprehensive.

We think BTR could grow into a rated asset class. Globally, about 11% of the S&P Global Ratings rated real estate universe contains multifamily or BTR portfolios.

This article addresses investors' frequently asked questions about the emerging sector. It includes the likely pace and scope of this market's development, and our criteria for rating vehicles holding such assets.

Frequently Asked Questions

Will the market support growth of residential rentals in Australia?

Yes, we think so. But the process will take time.

Australia's significant ongoing rental growth, historically low rental vacancy rates, and limited new overall dwelling supply are providing favorable market conditions to support this BTR asset class.

Strong net overseas migration is a key driver of demand, and thus far, housing supply is not keeping up. For example, in the year to September 2023, market commentators estimate a net deficit in housing supply of 46,500 dwellings.

This is why the federal and state governments are ambitiously targeting 1.2 million new dwellings over five years--with BTR potentially contributing about 10% of new housing supply.

However, we doubt growth will keep up with various federal and state government ambitions. Finding sites can be difficult, regulatory frameworks and tax regimes vary across states, and building costs are high and rising. Moreover, this is a nascent market in Australia, with untested returns which would prove to be a barrier for investors.

How fast will the rollout be?

Realistically, the BTR market will likely only emerge at scale after one to two market cycles (generally after 10-15 years). Which is how the purpose-built student accommodation market emerged in Australia and the BTR market has now emerged in the U.K.

According to real estate consultancy Urbis there are more than 50,000 BTR apartments in planning, approved with a permit, under construction or built. The planned units are facing funding constraints that are stifling their completion.

Colliers, a real estate services firm, has reported that the stock of BTR in 2023 is 4,790 completed apartments, which will be supplemented with a further 3,810 completions in 2024. Colliers expects that by 2026 this asset class will grow to 16,500 apartments. The largest projects are between 800 and 1,200 units and the smallest is 50; the minimum required to qualify for the proposed tax incentives.

Chart 1

The latest Australian Bureau Statistics data reveals that, year-to-date (May 2024), multi-dwelling approvals in Australia were about 59,000. In contrast, single-dwelling approvals were roughly 105,000. The above chart shows the growing and healthy pipeline of BTR approvals and early planning. Yet the supply of built BTR apartments is lagging this rate of growth in approvals.

Why the lag between approvals and new rental supply, and will this persist?

A few key issues include:

Shortage of sites.  This is affected by the high entry price of land, whereby developers are incentivized to produce build-to-sell (BTS) product to meet their return hurdles.

Non-uniform tax and policy frameworks.  To fulfil housing goals, state governments have sought to provide incentives for the BTR product to compete with the BTS product. State governments are formulating separate asset-specific planning policy frameworks. They include the diversity of the dwelling mix, size of the dwellings and car parking provisions. But a lack of uniformity across Australia's state jurisdictions is an impediment.

High project delivery costs.  The cost of creating new product must overcome the gap between new "off-the-plan" apartments and established and recently completed apartments. The cost differential can be up to 30% in many sub-markets due to the elevated cost of construction required to deliver new apartments.

Nonetheless, we think these obstacles will be overcome in time.

Permitting and zoning requirements are manageable for builders, and land constraints are mitigated by the choice to build up rather than out, along with the re-purposing of other real estate assets (such as hotels) into BTR properties.

Supply will be built where there is demand, so new BTR product is likely to be robust in Australia's major east coast cities. It will contribute to a population densification of the suburbs and help bridge the gap in that unmet housing need.

How does the shortage of rental units affect home-ownership trends?

It's a negative. The increased cost of renting is diminishing the saving capacity of first-time buyers. As a result, Australia is experiencing a long-term decline in home ownership.

Australia's median rents now make up about 32.2% of median income. This is according to a joint study by Australia and New Zealand Banking Group Ltd. and Corelogic, a property analytics firm. By way of comparison, in our portfolio of rated U.S. REITs, the rent-to-income ratio is in the low-to mid-20% range. In the U.S., a household is cost-burdened if they spend more than 30% of income on housing costs. As of March 2024, an Australian household with a new residential mortgage allocates about 48.9% of their median income to service a median dwelling value.

Australia's current (end June 2024) national rental vacancy rate is 1.3%, compared with a pre-COVID, five-year average of 3.3%. Further, according to SQM Research, the national house rents are currently growing at 8.6% and unit rents are growing at 8.8% annually. The combined growth is 8.7%.

How will these projects likely be funded? And are equity investors and creditors willing?

BTR requires substantial capital outlays with long payback periods. These BTR assets are suitable to be funded with long-term debt as demonstrated by our rated portfolios in the U.S. and Europe.

In our view, a lot of capital is looking for a home. Encouraged by potential tax and depreciation concessions, offshore capital is being deployed via equity funds that are operated by domestic managers. Several large well-capitalized players are active in this market.

Greystar Australia (part of Greystar Real Estate Partners LLC; BB/Stable/--) plans to raise institutional capital to acquire, develop, reposition, and manage rental housing assets across the region, with an initial focus on Sydney and Melbourne.

But in general thus far, institutional equity investors have found the low yields on residential versus other commercial real estate asset classes unappealing. In addition, a lack of market history makes it hard for investors to calculate the risk-return equation. The current stock of BTR being completed tends to be of a premium quality that commands a high rent and can justify an adequate return on capital. A secondary market for stabilized BTR assets would better inform equity investors as to the risk-return tradeoff.

The situation is similar for creditors. While residential lending is well established, BTR's infancy means it has not been able to demonstrate a track record of low-risk and stable earnings that would underpin predictable credit metrics. To date the BTR assets that are not skewed to premium quality have offered low returns to equity investors. For creditors the risk of high vacancy, anemic earnings and elevated financial leverage; needs to be reflected in the financing charges incurred by the BTR landlord.

In the U.S., according to REIT research and consultancy firm Green Street, about 5% of apartment ownership is held by REITs. There is negligible REIT ownership in Australia due to the sector's infancy.

Developers are usually unrated and seek funding for their BTR projects via the bank and the non-bank financial sector. Local developers would seek forward funding from BTR managers who are deploying capital into active funds.

What does a mature BTR market look like?

Our deepest rated BTR market resides in the U.S. Historically, this sector's earnings are somewhat cyclical and sensitive to economic recessions, given residents' short lease terms of about 12 months on average. Economic hardships or jumps in new supply generally result in pressure on occupancy and (in particular) rent growth, as tenants gain negotiating leverage at the time of lease renewal while landlords try to preserve occupancy.

In the U.S., the average portfolio size of the rated sector is more than 50,000 units and for the total market the median listed players unit size is about 30,000. For rated social housing providers the average size is 14,400 units. By way of comparison the population base of the U.S. is about 335 million people living in 130 million dwellings. In Australia the population is about 27 million living in 11 million dwellings.

As the Australian market is less than a tenth the size of the U.S., a mature BTR entity in Australia would have about 4,000 units. At this portfolio size the manager can obtain economies of scale with maintenance, selling and administration, and marketing costs. A portfolio of this size should also allow it to obtain meaningful asset and geographic diversity to mitigate individual asset and tenant risks.

What are the key credit factors for BTR?

We apply "Key Credit Factors for the Real Estate Industry" (published on RatingsDirect on Feb. 28, 2018) to the BTR entities. Under this criteria, the business risk assessment focuses on the entities: asset profile; market position; business strategy; scale; scope and diversity; and operating efficiency. The level and volatility of profitability is also a consideration.

The financial risk assessment focuses on a range of credit metrics including: debt to EBITDA; EBITDA interest cover; funds from operations to debt; and debt to debt + equity.

Specifically, for BTR entities we also assess the following:

• The occupancy rate and incentives provided by the landlord (usually including rent-free periods).
• The loss-to-lease rate, i.e., the difference between a units market rental rate and the actual rent stated on the signed lease agreement.
• The average length of stay and the retention rate of tenants that remain in the complex when leases come up for renewal.
• Rental affordability of single-family homes versus apartments. This also extends to the relative affordability of renting or owning. It would include the track record of tenants moving out to purchase homes.
• Average rent being charged when compared with peers and relative to the broader private investor offerings.
• The appetite for development. While it's hard to generalize, in the U.S. this can be up to 10% of total gross assets.
• The level of predetermined funding and construction costs prior to undertaking the build.
• Whether diversity of location is evident at the outset or an aspirational target. Specifically, if the mix straddles properties located within the inner loop of a city in suburban locations or satellite cities, as well as in downtown/CBD areas.
• The asset quality of the portfolio that extends to the style of apartments such as whether they are low rise or high rise.
• Diversification of apartment quality provides choices for renters and adds to cash flow stability for the REIT throughout the course of a rental cycle.
• Strategy of budgeting for operating expenses. Ability to respond to the impact of rapid and unexpected increases that could dampen profitability. Property taxes are the largest expense line item for residential REITS and have been going up with rising asset prices. Other outgoings are insurance, payroll, utilities, and maintenance costs. To date the insurance costs have been elevated.

Chart 2

How will the BTR market evolve in Australia?

Australia's chronic undersupply of residential units is not, in our view, unsolvable. We think the market will be able to diversify the property mix and add the housing where it is needed--in areas that exhibit attractive population and job growth. However, it will take time.

The gradual buildout will not, in our view, become an issue for the BTR asset class. At least not relative to other real estate sectors. In fact, "high barrier to entry" is somewhat of a misnomer in BTR, given a lack of affordable housing nationwide. This undersupply is likely to persist for the next few years.

Editor: Cathy Holcombe

Related Criteria

• Criteria | Corporates | Industrials: Key Credit Factors For The Real Estate Industry, Feb. 26, 2018

Related Research

• Signs Of Stability Are Emerging Amid Challenging Conditions In Real Estate, July 2, 2024
• German Residential REITs Remain Supported By Funding Access And Solid Rent Fundamentals, May 31, 2024
• Real Estate Monitor: Rising Rates Driving Rental Housing Resiliency, March 30, 2023

Appendix: Rated Landlords With A Residential Focus

Table 1