A timely saviour or a bad omen?

A new investment asset class has been created around the world as a direct result of global runaway property prices. The genesis of the build-to-rent idea was due to the after shock and recovery of a property bubble that got way out of hand in 2008, the result of which was the global financial crash (GFC).

The aftermath of the GFC saw countless families having to walk away from their homes either because they couldn’t sell them due to negative equity following the crash or they had lost their jobs and couldn’t pay their mortgages. The situation was so dire that tent cities sprung up in suburbs to house people that were caught fowl of the financial crash (1). In the writer’s point of view, it was the rating agencies that rated very risky investments as prime quality ones, which fed the greed and dishonesty that led to the failures of the financial markets. Every man and his dog could get a mortgage as long as the paw print on the document was un-smudged and all the questions were answered. This of course led to people borrowing well above their means, the feasibility of the deal and affordability taking a back seat to the salivating bankers adding to a portfolio that they may already have packaged and pre-sold.

These dodgy mortgages were all put together, partnered with some safe bonds and then the whole package called something like: ‘Prime Blue-chip Capital Investment’. I would invest in something with a name like that! The shiny new package was given to a rating agency and a AAA rating was requested. The rating agency was paid a huge fee once the rating was given and if the rating was not high enough, there were other rating agencies waiting in the wings to give the bankers what they wanted in anticipation of an escalated fee for services rendered.

So, the investment bankers got their AAA rating.

The Federal government in the USA has passed an Act called the Commodity Futures Modernization Act [CFMA] in 2000 which ordered that financial products such as derivatives must not be regulated (2).

The leash was off and with human nature the way that it is, this was always going to be a time bomb. It went off in 2008.

A parallel can be drawn in New Zealand in 1995 when the government allowed untreated timber to be used for house framing. Around the same time, the Council funded advisory service BRANZ, allowed the direct fix monolithic system to go ahead. With the cheaper costs of untreated timber and the easy cheaper cladding system, developers went to town building streets of duplex’s and pocketing huge profits. So, not unlike the GFC, when regulation is not properly thought out, people can and will find the loop-holes then try to get in and out before the system crashes into a brick wall.

Human nature ran with the change in regulation, developers made huge profits and this too came crashing down with estimates that leaky homes cost NZ close to $47 billion (3).

But as every optimist knows, with every adversity comes a seed of hope. When the NZ government let go of the reins, a housing boom was created and many who navigated well by doing their own research, benefited greatly during this boom period between 1996 and 2003.

The aftermath of the GFC of 2008 birthed an unnatural monster-child between the unlikely couple of the blossoming rich and the disparaging poor. The widening economic gap between the two was what bought them together as the created void by the GFC was begging to be filled. The monster-child looked and smelt like a new home for those left behind, it had security of tenure (10 year term), the tenants can give notice (sell) if they wanted but the landlord can’t tell them to leave and the tenants can make minor changes to the house with the landlord not being able to refuse. The majority of people that now fell into the poor category had seen their hopes of the quarter acre with a picket fence disappear over the skyline, promising never to return. It was hard enough surviving with the food and rent increases in the current high inflationary environment let alone trying to save $150k plus for a deposit, so this new hybrid idea of owning and renting seems timely and welcome.

So, this monster child started to grow. Large housing companies in the USA had already started gathering (buying) up all the houses that were left empty after mom, pop and kids packed up to move to Tent City. The momentum kept growing and then two major players, Starwood and Blackstone merged to collectively own 82,000 home units (4).

In addition to this conglomerate, Cushman and Wakefield have estimated that about 120,000 more build to rent homes will be built in the US in 2022, this being a 30% increase from 2021. With the rent increasing 15% per annum, you can see why institutional investors were targeting this sector. The UK and Europe were next, quickly noticing and picking up on the trend in the US. Research carried out by Savills in the UK showed the demand for the single family home is the fastest growing sub-sector in Britain (5).

So, what about us here in NZ? After sitting on the side lines observing for a while, the government has decided that this idea could be beneficial. Not only would it take away the heat of the non- starting kiwi build programme, but it could also relieve the increasing waiting list for government housing. All the government would have to do is follow the overseas model and provide an incentive or two.

The government have now introduced the following for discussion (6):

Tenants must be offered a fixed-term tenancy of at least 10 years with the ability to give 56 days’ notice of termination, but they may agree to or request other tenancy offers. Note that in order to qualify as build-to-rent:

at least 20 dwellings in one or more buildings that comprise a single development, on either a single parcel of land or multiple contiguous parcels
the dwellings and any common land or facilities for those dwellings have a single owner
dwellings can be held in one or more titles
the building that a build-to-rent dwelling is in can include other dwellings or commercial premises that do not form part of the build-to-rent development (for example, an apartment block that has shops on the ground floor.
the dwellings are used or available for rent under the Residential Tenancies Act 1986
explicit personalisation policies must be offered, over and above the Residential Tenancies Act 1986

For existing build-to-rent assets, interest will not be phased out. Taxpayers who hold existing build-to-rent assets will not be subject to the interest limitation rules for the short period of 1 October 2021 to 31 March 2022, and will continue to be exempt in perpetuity.
For new build-to-rent assets, initial investors will be able to deduct interest for as long as they hold an asset and operate it as a build-to-rent development. Any subsequent investor(s) can deduct interest for as long as the asset is held and operated as a build-to-rent development.
does not have to accept a 10-year tenancy offer. A build-to-rent development will satisfy this requirement as long as a 10-year tenancy term is offered.
To qualify, developments need to offer tenants leases of at least 10 years. Tenants can ask for shorter agreements if they wish and the development will still qualify for the exemption. Tenants will be able to break their tenancy agreements at any time, with a 56-day notice period.

There is one big item in the above list that will sting the mom and pop investment property owners in NZ and that is the interest deductability that these big players have been awarded.

On the side, it is interesting that left wing governments such as that in the US and NZ are promoting large scale capitalist monopolies at the expense of the thousands of Mom and Pa investors looking to secure their retirement. It would make sense if these Socialist governments controlled and bank-rolled the build-to-rent schemes themselves, but to take from the general public (investors) and to give to large corporations, is confusing as it much more of a right wing policy and against the socialist grain.

Be that as it may, the machine moves forward and as long as there is demand, supply will follow. The next step would be to attract the institutional investors, ideally the Kiwibank funds to invest in these schemes. Colliers research have looked at a few different asset classes to compare the returns of the Build-to-rent investment (7):

It is always difficult to compare residential and commercial property investments due to the different benefits that one receives from each sector. For example, commercial investors have the tenants pay for maintenance, land rates and often the property management fee. A residential investor has to pay all these expenses him/herself. So, to equate the classes, Colliers have taken 30% off the residential rental return for the non-recoverable losses but also extrapolated the residential capital gain by spreading it over the term and adding this to the rent and returns.

Looking at the graph, if we take that eye-opening equity bar out of focus, we see that the residential and commercial returns are fairly close. Commercial property has typically provided better returns than residential and without the current surge in residential prices over the last 10 years, they would continue to do so. Still, the consistency of NZ’s property cycle is almost a rule and come hell or high water with the GFC and Covid, the residential property cycle, although a bit skewed with a thirteen year growth stretch this time, can still be relied upon. Institutional investors have recognised this and are starting to invest in this new asset class.

After a lengthy considered delay Build-to-rents took off in NZ and now in Oct 2022 the recognised rent-to-builds in NZ include: The Ed and the Nix in Auckland, Okhams model in Mt Albert, Kerepeti in Hobsonville Point, Arc Onehunga in Auckland and Toru in Queenstown (8). Even publicly listed Kiwi Property that specialises in retail has jumped on the bandwagon and will be building 295 Build-to-rents in Sylvia Park by 2024.

When we look at these and look at what happened in the US with the mergers to eliminate competition, we don’t need to look far within our shores to see where this could happen here.

A large player and kiwisaver provider, Simplicity living has joined forces with NZ living to build a planned 10,000 affordable houses over the next ten years. NZ Living seems to be ploughing forward ignoring any obstacles that jump in the way of their progress. When they looked at the gib board situation with the Fletcher monopoly, they quickly sidestepped this issue and purchased a similar product from Thailand. A spokesperson for the company said they were able to get plasterboard 20% cheaper and Aqualine board 40% cheaper from Thailand. It was not only the price that was more attractive but the spokesperson from NZ Living said that the delivery time was two months from South Asia compared to six months from South Auckland. They have now ordered four containers of plasterboard per month from Thailand for the next three years (9).

If the Simplicity Living/NZ Living partnership works, this will see them compete with Housing NZ (Kainga Ora) and become the second biggest landlord in NZ. The partnership will sell down units in the fund to wholesale investors, much like what you would see with the likes of Augusta (Centurion), Oyster Fund Management, SCI and PMG Funds. The wholesale investors will own a share and be paid a monthly or quarterly returns from the rent. So with Kiwi Property and Simplicity in the game both public and private equity has the market covered.

So, is all of this a good thing? How long will it take before NZ follows America and the larger companies combine to create a giant conglomerate to become the largest landlord in NZ? Will the Commerce Commission monitor it? We need to remember that unlike government housing, this rental stock will not be subsidised, in fact quite the opposite; due to the Simplicity Living model of passing returns to shareholders in the private equity space and Kiwi property in the public shareholding space, their responsibility will be to keep the rent at the highest point possible to appease their shareholders.

I see a bad moon arising with a creation of a new class of people, those that used to strive to buy a house will now settle into a build-to-rent, the shareholders of the conglomerates that own the homes will push for the rents to increase to give themselves a slightly higher dividend. The people from the build-to-rent areas, thousands of them, will revolt and fight back. The Hunger Games comes to mind.

Primarily, the build-to-rent child was born out from the aftermath embers of the disastrous GFC. This may look like the ideal solution to provide tenants with more rights and security of tenure, however I see a massive fallout by the eradication of the private investor trying to secure his/her retirement and the gap between the rich and the poor going from a crack in the sidewalk to something more akin to the grand canyon.

References

A timely saviour or a bad omen?

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