A spotlight on the build to rent sector

Ray Pittman is the President and CEO for Australia and New Zealand of CBRE, which is the commercial property real estate agent. We’re talking about Australian commercial property and in particular focussing on what’s called the build to rent sector in the US.

In Australia, developers build apartment blocks to sell them and they sell all the apartments. In America, it’s called build to rent where they build an apartment block and then they hold them and rent them out and it’s a long term asset. We don’t have that in Australia, apparently the tax treatment is such that it’s not advantageous so it hasn’t happened and what they’re trying to do is get the tax changed.

According to Ray, there are signs that it is changing. It’s an interesting subject. We also tackled online retailing and the impact on both retail commercial property and warehouses and also the fact that Australia continues to be a bit of a target for international commercial property investment and in fact Melbourne is the number two destination at the moment in the world for commercial property investors. 

Here’s Ray Pittman, the CEO and President for Australia and New Zealand of CBRE.

Ray, you’ve apparently recently moved from CBRE’s US business to Australia, how different is the Australian commercial property sector to America’s, what sort of things have struck you?

Well, it’s been about three years now, I moved here just over three years ago.  So, that’s been enough time, certainly, to get settled in and to get a feel for things and to understand a little bit about how the different markets work but certainly not long enough to become a real expert.  A couple of things that I would notice as key differences, one of the ones I know we’ll talk about later but a couple of key asset types really aren’t as prevalent or as big a part of the business here as you’d see in the US, so the multi-family or the build to rent sector is the largest investment sector in the US, and really in its fairly early stages here in Australia. So that’s a big difference in the property market in general.  We’re certainly very involved in the build to sell residential model and we’re eager and keen to be a leader in the build to rent model but that really hasn’t taken hold here yet.  Then, similarly with healthcare as a property sector type.  Obviously, the US healthcare market is more privately driven where the Australian market is more public healthcare but we see that as a major asset class also.  Those are things that kind of jump out at you but a lot of things are similar, the markets do function in similar ways, similar dynamics, it’s not dramatic differences and just the way that business operates country to country.

I think Australia has been a very innovative market in terms of building types and the sustainability and the construction of office buildings, and a lot of things.  So, I think in general fairly similar with a few key differences.

Describe the build to rent sector in the US for us, who funds that, who are doing the owning and the renting?

Well, build to rent in the US now would be a major part of the property industry.  You see equity investment coming from across the board, institutions, private investors, private developers, equity coming from all sources and the same with debt, you see major banks lending, you see offshore lenders and then long term there are a handful of bigger institutional owners, including Greystar, who’s now looking at getting actively involved in Australian market, but it’s a very robust part of the business.  Again, it’s the largest property sector for investment overall in the US and it’s much more of a generally accepted rental model too for home owners, for renters, for consumers.  You see that happening in all markets, virtually every US market is pretty well built out now with an extensive build to rent market there.

With the build to rent market are many of the investors individuals either through 401Ks, which is their version of self-managed super funds, or just directly outside?  Is it an individual thing or only institutions and are people doing it through mutual funds, are mutual funds doing it as well in order to aggregate individual investors into build to rent?

No, I don’t think, Alan, you wouldn’t see mutual funds investing, you’d see a lot of apartment REITs in the US.  You do have individual investors.

I suppose that’s what I meant, apartment REITs, there’s apartment REITs are there?

Yeah, I think the real difference is this, so you’ll see mum and pop investors who want to invest in the rental market, sure, but they’ll do it through a REIT.  A REIT then aggregates all that investment, they put the money into a major apartment complex and it’s institutionally run and managed.  The difference in Australia, you have a lot of people with self-directed super funds, that type of thing, and they’re individual owners.  The risk profile is a lot different for the local Australian investor, they’re not aggregated with other investors.  But, the big difference also is on the demand side, the experience for the renter is dramatically different.  I think sometimes the conversation in Australia so far focusses so much on tax regime, so much on where the money is coming from and I think that’s missing the point.  It’s a totally different user experience also.  The rental market is pretty sophisticated in the competition in the US and you have high end rental communities competing for renters with amenities, with services like concierge services, with events and planning, it’s a very competitive market. 

Whereas in the Australian market you have thousands or tens of thousands of mum and pop investors just offering their own little units and there’s not a lot of service that goes with it, there’s not a lot of amenity, there’s not a lot of planning, there’s not a lot of some of that event and hospitality thing that goes on, it really does feel different.  I think people don’t realise yet if you offer that type of a rental community into probably any city in Australia once people figured it out I think they would realise that’s a better offering for the consumer because you’ve got professional ownership and management of your building instead of a local mum and pop that you’ve got to track down and try to get to fix the problem.

Are you seeing signs of that kind of build to rent market and apartment real estate investment trusts emerging in Australia?

Yeah, definitely.  I think it’s emerging.  I think it’s in the early stages but we feel confident that it’s going to continue to emerge, we don’t think it’s a short term topic of the month.  I think we think it’s a long term trend that over time will help reshape the rental market in Australia and I think you’ll see more developers looking at build to rent and fewer build to sell only partly because of the pricing, the cost of construction, the cost of land, it’s getting very expensive to build and buy apartments and there are just a lot of – if you look at studies of millennials more than half, I think something close to two thirds, suggest that they might not ever be a home owner and so rental communities are a desirable outcome.  Whenever you have extensive buyer demand or renter demand you’re going to have developers looking for creative ways to meet that demand.  Right now, yeah maybe the financing and the tax regimes aren’t really favourable yet but we think that’ll change over time but what is pretty clear is we think there’s latent demand for that kind of product and that that’s really going to be what drives it.

What sort of government or tax support is needed?

Well, certainly allowing managed investment trusts to invest in build to rent would help and there’s a number of other things that could be done to help.

Isn’t that allowed now?

No, the tax treatment of managed investment trusts is less favourable than it would be for other asset types and I think there’s actually discussion underway now that managed investment trusts would not be allowed to invest in build to rent product and so that would be a major detriment.  But probably we think at least that would be to the detriment of the Australian public to not be able to bring to market a more desirable and hopefully more affordable rental opportunity, it wouldn’t seem to be the best policy to us.

Are you saying that the real estate investment trusts that currently exist that own shopping centres and office buildings and so on, obviously there’s lots of them around listed on the stock exchange, are you saying that they’re not allowed to own residential apartment blocks?

I’d have to get back to you on the details, Alan, I don’t want to quote the wrong policies and regulations.  But, what I can say is the tax treatment of build to rent residential is less favourable than build to sale residential or build to rent office for example, other product types, and that managed investment trusts today I don’t think are allowed to invest in build to rent residential or at least the tax treatment is such that it makes it effectively off the board for them.

Right, okay.  When you say that there are signs that it’s happening it’s basically a conversation with the tax office and the government about it rather than institutions or companies starting to do it.

Clearly, yes.  I think when we talk to our major developer clients issue number one is regulatory and tax policy.  I think the institutional developers that would like to jump into this product right now their number one issue would be regulatory and tax policy.  I think that our point is yes, we agree, but we think that long term the potential demand for a better rental product is going to be such that it’ll eventually overcome that in one way or the other, either the returns will become more attractive to overcome the tax deficit or that government policy and taxation will change and it’ll become a much more attractive place.  At that point I think you’d see a lot of debt and equity flow into the sector because I think people do realise there’s an opportunity there.

Let’s just talk about commercial property now, obviously the big trend that’s quite interesting is the rise of online retailing which presumably is having a negative effect on retail property but a positive effect on industrial property because of the demand for warehouses, is that what you’re seeing?

That we can all see coming now, but we work with a lot of retail developers and investors and I don’t think we’d say it’s negative for them, it’s just putting pressure on to evolve and by evolving they probably need to create more experiential opportunities at their centres.  Food and beverage is actually doing quite well right now, you’re seeing more programming at retail centres, more events, more promotions, more things going on.  So, they probably need to change their tenant mix a bit and they probably need to think about not being just a destination for shopping because your laptop can now be a destination for hopping but your laptop will never be an experience and your laptop will never offer real social engagement, you never can get food and beverage sitting by yourself at your screen.  All of those things require well-run, well thought out and well managed retail centres and we think that the people who do that well are going to thrive in the future, they’re not going to be negatively impacted by this.  Because, human beings are social animals and they still want to interact and a retail centre with great food and beverage offering and some programming and some fun things going on with other people, that’s always going to be an attraction.

But, do you think that it’s possible that there’s going to be a place for fewer of them, or is it the case, do you think, that there are going to be less experience shopping centres around or a need for less of them than there were for actual just shopping destinations?

I don’t know that, that’s a good question.  I think the types of centres developed in the future will definitely change and I think what used to be purely a destination centre where you just go pick up some goods and leave you’ll see less of those types of products developed and I think you’ll see more that are more town centre oriented, more experiential.  But, whether that means there’s less retail in the future or not I wouldn’t guess so.  That has happened in the US, demand has declined in the US, but I think you’ve probably seen the statistics before, per capita retail properties in the US are in the range of 3 to 4 times greater than in Australia and I think underlying that when some of these online pressures began to build in the US the US was over-retailed but now that these pressures are coming to Australia, Australia is not over-retailed.  We don’t have massive overbuilding that we have to work off and some centres in the US are having to be repositioned as other uses but we’re not projecting that for the Australian market.  We’re projecting a shift in retail and some creative adaptations will be required and the nature of retail might shift a little bit but we’re not saying fundamentally the retail sector is going to have a problem or go backwards or need to shrink or centres are going to need to be torn down or repositioned because we don’t have that same level of over-building that the US had when they entered this phase.

Is that why there’s a fair bit of international money coming into Australian commercial property?

I don’t know if that would be the specific reason, there is a lot of overseas capital coming into Australia, quite a bit.  In fact, you might have seen this by our recent investor sentiment survey continues to identify Australia as a top destination for international capital.  Probably less coming out of China, maybe being made up with more coming out of Singapore but still the Europeans, North Americans, Canada is placing a lot of money here, it remains a great destination.  But, I don’t know that it’s because of the under-building, and particularly not for retail.  I do think the fundamentals here particularly in Sydney and Melbourne are very good, they can see as very low rental rate increases continue yields remain probably lower than investors would like but they’re stable, they’re not wildly fluctuating markets where there’s a lot of risk. 

These are very healthy stable markets in a country with strong rule of law, good transparency, good support for property rights, there’s every reason for investors to want to park money in the Australian market and we’re just continuing to see that.  What’s been interesting is a little bit of a shift as the yields in Sydney continue to get tighter and tighter, harder to find return here.  Melbourne actually has jumped up the list and is now, by our study, the number two target market worldwide for overseas investors and Sydney actually dropped from the number one spot down to the number six spot, still really strong but slipping a little bit.  That’s not about market fundamentals, that’s just about the yields here have gotten so sharp that it’s hard to get a reasonable return in the Sydney market now. 

So, which market is number one?

Good question, I may have to send you – I should know that but I know it’s not in the Australian market.  I don’t remember if it’s an Asian market or European market, we’ll find that out shortly. 

But, Melbourne is globally number two now?

Yeah, Melbourne is number two, Sydney dropped to number six and Brisbane actually is number nine, I think, not eight, eight or nine.  So, Brisbane popped up which is interesting because that’s a little bit counter-cyclical, it hasn’t been as healthy and as strong a market as Sydney or Melbourne but as they’ve started to come out of the resource lag I think investors are increasingly seeing opportunities in Brisbane.

What does that data tell you about the likely future of the next few years for investment in commercial property in Australia, does it tell you anything or not?

Well, it does.  I think what we’re going to see is a continued in flow of overseas capital.  Although the Chinese have slowed down a little bit that’s more due to government regulation than market dynamics.  We don’t think the market itself would have necessitated the slowdown in Chinese investment and it has been picked up by Singaporeans but I think market fundamentals remain strong here, it’s a stable market.  We don’t see dramatic fall off in overseas investors, we think that’s going to remain strong.  What may happen or what is happening already is a little bit of a shift to Brisbane and interestingly a little bit of a shift to Perth as investors realise they do need to get a certain yield on their investment, Sydney and Melbourne have become fully priced and Brisbane and Perth are offering better yield opportunities at a reasonable point in the recovery where they can expect more upside in the years ahead.  So, that’s becoming attractive.

That was Ray Pittman, President and CEO for Australia and New Zealand of CBRE.