Build-to-rent lessons from abroad

Overseas trends in the build-to-rent (BTR) sector provide the blueprint for the growth of the asset class in New Zealand.

Recently, Charles Cooper, Auckland Managing Director at Colliers, and Alan McMahon, National Director of Strategic Advisory at Colliers, travelled to the UK alongside a group of clients to meet industry participants and inspect BTR assets. This followed an earlier trip to Melbourne.

Some industry participants are already active in Australia and their familiarity with the market there makes them the most likely to invest in New Zealand in the short to medium-term.

McMahon says in Europe the key institutional players typically like to participate in active management of the asset, known as the ‘opco’, as well as to own or have a shareholding in the asset itself, the ‘propco’.

“Capital deployed by them and the North American investment groups might be into joint ventures with local developers on specific assets, or by investment into their companies, to fund a pipeline of assets to develop and own,” McMahon says.

“This pattern is already evident in Australia, where thousands of units are underway backed by various capital arrangements.”

Interest in passive investment demand is also building, where investors want to tap into the almost bottomless pool of residential tenants in cities like Auckland and Wellington, but avoid day-to-day management of the assets, which is an intensive operation.

The more active style of BTR management will include organising events for the resident community.

Typically, co-living developments feature a high percentage of small rooms, rather than apartments. These rooms are fully furnished and feature en suite bathrooms and kitchen facilities. The idea is that residents live in the whole building, not just their room.

“Many of the buildings we saw overseas included bookable kitchens and dining rooms enabling residents to host dinner parties, while there were also movie rooms, games rooms, common laundries, and various event spaces where wine tastings, and yoga or pilates classes were held daily,” McMahon says.

The challenges in the UK BTR market are like the challenges here. High debt costs, high inflation curbing personal spending on things like rent, high construction costs, and tax and planning systems getting used to the asset class.

“But in the UK and more recently in Australia, investors have worked out how to develop cost-effectively, make acceptable returns, and limit risk. Demonstrating a reasonable return for the risks taken will attract investment capital and secure debt, and that’s what the successful UK developers have done.

“Our aim was to learn more about the mix of ingredients required for success and how those learnings might be translated into a New Zealand context.

“Of course, there’s no one answer. Each of the 13 assets we saw were different, in terms of market segment, location, typology and operation, but there were some common factors.”

High house prices, a poor renting experience historically, growing populations, strong immigration, and white-collar employment numbers are prevalent components. While different scales, London, Manchester, and Auckland along with many other cities fit this description.

Residents of modern high-quality BTR assets tend to be mainly young professionals. They value quality, security, and good public transport.

Residents in BTR communities will typically stay for a year or two but vacancies are easily filled and there is always a ready supply of new residential tenants, making the asset class typically less volatile than the traditional office and retail sectors. Occupancy of over 95 per cent is the norm.

Overseas developers, usually also the managers and owners, were conscious of both rental returns and capital growth. The market weakened in the UK, as everywhere else a few years ago, and capitalisation rates of sub-4 per cent are now more like 4 per cent to 5 per cent.

Returns on development costs typically exceed 5 per cent but with these tight returns, it is not surprising that most investors develop their own, rather than have to buy from a developer seeking a profit or development margin in return for constructing the asset with all the risks attached.

Strong projected rental growth and an expectation of growing investment demand means feasibility analyses predict a total return, or internal rate of return, of over 10 per cent which helps to counter the modest initial rental returns.

“The numbers are similar in New Zealand,” McMahon says.

“We are working on several BTR and co-living developments in Auckland and Wellington which share the same characteristics as those we saw in the UK and Australia.

“There is no doubt that we are following along the same track as the UK and Australian markets. While the number of completed units is small, the work we’re doing on planned developments here suggest it won’t be long until a high-quality, long-term, and secure rental option will be a reality for thousands of New Zealanders.”

- Article supplied by Colliers