Australia’s housing crisis and return of Chinese students a blessing and a curse for build-to-rent market

The housing crisis has focused attention on purpose-built rental housing that is typically owned, managed and operated by institutional investors
Australia’s market shows promise, but the sharp rise in construction costs and interest rates have cast doubt on the feasibility of new projects

Nicholas Spiro

Published: 4:15pm, 8 May 2023

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Australia’s National Housing Finance and Investment Corporation (NHFIC) does not mince its words. In a report published last month, it said that “at a time of returning migration, [the housing market is] contending with a perfect storm of high inflation and interest rates, slowing supply and record low vacancy rates”.

For prospective first-time buyers, the storm has felt like a category 5 hurricane. Notoriously unaffordable even before the Covid-19 pandemic erupted, Australian housing has slipped further out of reach for most would-be buyers. Despite having just suffered the sharpest fall in prices on record, the median value of a capital city dwelling is still 12 per cent higher than in March 2020, according to CoreLogic data.

More worryingly, the rental market has become increasingly unaffordable. The average rental increase in the capital cities last month reached 11.7 per cent year on year, an all-time high. The sharpest rises were in flats. In Sydney and Melbourne, rents soared 19.1 per cent and 15.2 per cent respectively, according to CoreLogic.

Several factors are at play. First, the reopening of Australia’s borders caused a stronger-than-expected increase in population growth. This has been driven by a surge in net overseas migration, with foreign students accounting for a large portion of the arrivals.

International students accounted for more than 40 per cent of tertiary enrolment before the pandemic. Many of these students rent flats in the capital cities, particularly Sydney and Melbourne, helping to drive up rents.

The return of Chinese students has heightened concerns over rental affordability. Beijing’s snap decision in January to no longer certify online degrees awarded by foreign institutions was seized on by the media, fanning fears about tens of thousands of Chinese students flooding back into Australia.

Second, chronic supply constraints have been exacerbated by the dramatic rise in interest rates and the surge in construction costs, adding to long-standing problems related to planning and zoning. The NHFIC anticipates a shortfall of 62,300 flats and medium-density dwellings in the next five years.

The housing crisis has focused attention on build-to-rent (BTR) developments: purpose-built and designed rental accommodation that is typically owned, managed and operated by an institutional investor for a long-term period.

Unlike in the United States, where the multifamily sector is well established and has the highest share in commercial property transaction volumes, the Australian market is in its infancy. According to data from EY, there are just 23,175 units nationwide, more than half of them in Melbourne. However, less than 4,000 of them have been completed, with the rest in the planning phase or under construction.

The rationale behind BTR in Australia is clear – the opportunity to capitalise on the shift to rented accommodation, exploit the potential to deliver additional supply at scale, increase the diversity of the rental stock and institutionalise a sector favoured by global investors because of its resilience and stable returns. Even so, the challenges facing the sector have become more acute in the past year.

Prospective buyers look at models of flats on sale at The Parkside in Macquarie Park in Sydney, Australia, on February 25. Photo: Reuters

The sharp rise in construction costs and rapid increase in interest rates have cast doubt on the financial feasibility of new projects, especially among smaller and highly leveraged developers. Some schemes are being deferred, or even abandoned, as part of a repricing of land values.

More worryingly, eye-watering rent increases have thrown into question the affordability of BTR housing. Given that these developments are premium properties in highly desirable locations, targeted at renters with higher disposable incomes who are seeking superior amenities and a strong customer experience, they will do little to address the lack of affordable housing.

However, rents have soared partly because of the severity of supply shortages, underscoring the desperate need to boost housing starts. “Right now, BTR is a premium product because it has to stack up,” said Richard Temlett, director of research and strategy at Charter Keck Cramer in Melbourne. “Yet, any increase in supply will help put downward pressure on rents.”

Several major global developers and investors are betting that BTR will become a more widely accepted form of housing in Australia, leading to a more mature and liquid asset class. Although this will require stronger backing from state and federal governments – BTR developers are currently at a disadvantage from a tax standpoint, partly because of a lack of regulatory clarity – the opportunities are vast.

People walk past a property agent’s window in Melbourne on March 7. The Reserve Bank of Australia raised interest rates for the 10th consecutive meeting in March, taking the cash rate target to 3.6 per cent. Photo: AFP

The combination of a major repricing of site values, firm evidence that the BTR model works and has significant potential in other capital cities, plus the scope for big developers to scale up in a sector poised for growth, suggests that more institutional capital will be deployed in the coming years.

Hines, a large US real estate developer and investor, teamed up with the property arm of Canada’s Ontario Teachers’ Pension Plan last November to develop and acquire up to US$1 billion of assets in Australia’s BTR sector. “Right now, there’s an opportunity to pick up attractive sites at once-in-a-lifetime prices,” said Ray Lawler, Asia-Pacific chief executive at Hines, adding that Australian BTR “could become one of the most significant things we do in the Asia-Pacific”.

For the time being, Australia needs to develop a critical mass of BTR projects if it hopes for the sector to become firmly established. The headwinds during the past year have made this more difficult, but boosting supply is key to addressing Australia’s housing crisis. The potential of the BTR market needs to be unleashed.

Nicholas Spiro is a partner at Lauressa Advisory