Build to rent: regulatory change paving the way for foreign and domestic investment

Build to Rent (BTR) assets are large-scale, purpose-built rental housing buildings, where developers (instead of selling) retain ownership and receive returns in the form of rental yields. Rent may be set at market rate, or in the case of affordable housing, be discounted with government support. BTR is another mechanism aiming to alleviate the lingering and ever-increasing housing affordability crisis in Australia by increasing the supply of housing while facilitating access to affordable with the security of long-term tenure.

In Australia, the BTR industry is in its early stages. According to this report by EY commissioned by the Property Council of Australia (PCA Report) there are currently 11 BTR properties worth A$16.87 billion, which make up 0.2% of the residential housing market. While overseas (particularly in the US (12%) and UK (5.4%)) BTR is a well-established asset class, both providing investor returns and affordable housing. If BTR in Australia grew to 3%, the sector would be worth approximately A$290 billion.

The proven success of the BTR model in other countries serves as an indication of how BTR could operate effectively in Australia. For example, in the United States, sales tax varies by state but the Low Income Housing Tax Credits program awards developers federal tax credits to offset construction costs in exchange for agreeing to reserve a certain fraction of units that are rent-restricted for lower-income households. Canada has gone one step further by announcing on 14 September 2023 that the Federal Government will remove GST on BTR housing to incentive construction of much needed long-term affordable housing. Compare this to Australia where BTR developers are currently unable to claim GST credits on related expenses such as land acquisition, construction and other development costs.

As with economic infrastructure, BTR projects generally have a delivery and operation phase. During the operation phase, homes are managed through professional on-site teams to ensure that tenants are retained for a longer term than when compared to other residential classes which are not managed. This results in steady cashflows and stable long-term returns for investors, as tenants commit to longer lease arrangements. With the decline in traditional development markets such as commercial buildings which struggle to find tenants, it is clear that BTR is emerging as an attractive opportunity for investors in the construction industry. In turn, tenants are provided with stronger economic and social benefits when compared to traditional private rental arrangements.

Opportunities for BTR in Australia

Australia’s BTR industry has lagged behind other markets for several years due to an array of regulatory headwinds such as a lack of tax incentives, onerous planning requirements and a laborious Foreign Investment Review Board (FIRB) approval process. However, with recent regulatory changes, favourable market conditions are making Australia an attractive investment destination (particularly for international real estate funds) who are starting to view Australian BTR’s as a sustainable, low-risk, long term investment opportunity. Below are some reasons why:

Supply and demand

It is no secret that Australia is suffering a housing crisis, particularly in the major population centres of Melbourne, Sydney and Brisbane. The National Housing Finance and Investment Corporation (NHFIC) forecasts a shortfall of 106,000 residential dwellings by 2026 and, to address the shortfall, the Government has set a target of building 1.2 million homes by the end of the decade.

FIRB reform

On 1 May 2024, the Australian Government released an updated foreign investment policy document (Policy). Previous government policy prevented foreign investors from purchasing established dwellings unless they were to be redeveloped for additional housing or met specific tests for residential premises. With the introduction of the Policy, foreign investors can purchase established BTR properties, with the FIRB approval process to be streamlined for passive institutional investors with a “strong track record of compliance”. To support this, Treasury is setting a new performance target of processing 50% of investment proposals within the 30-day statutory decision period from 1 January 2025.

Treasury is also reducing administrative burden on repeat investors, where an investor’s ownership structure has not changed since their previous foreign investment application. This measure is aimed at encouraging repeat investment in BTR developments

The Policy builds on Treasury’s BTR-friendly announcement on 10 December 2023, where it was announced that application fees for foreign investment into BTR developments will be reduced by applying “commercial land” application fees rather than the higher “residential land” fees. To illustrate, if a foreign person were to acquire land for A$40 million, the FIRB fee has been reduced from approximately A$1.1 million to A$14,000.

Federal proposed BTR tax concessions 

The concessions were introduced to Parliament on 5 June 2024, and are contained in the Treasury Laws Amendment (Build to Rent) Bill 2024 (the BTR Bill) and the Capital Works (Build to Rent Misuse Tax) Bill 2024 (the Imposition Bill). 

On 4 September 2024, the Senate Economics Legislation Committee handed down its report which details its inquiry into the Bills. The Senate have recommended that the Bills be passed. However, the Coalition, Greens and independent senator for the ACT, David Pocock, provided dissenting comments or recommended the Bill be passed only if changes were made to the Bills. 

BTR Bill

The purpose of the BTR Bill is to increase BTR housing supply through using tax concessions as a lever to incentivise long-term foreign investment in the sector. The concessions under the BTR Bill are as follows: 

1. increasing the capital works deduction rate from 2.5% to 4% per year for eligible new BTR developments; and
2. reducing the final withholding tax rate on "eligible fund payments" and capital gains from Managed Investment Trust (MIT) investments for eligible BTR developments from 30% to 15%, with application from 1 July 2024. 

Eligible fund payments include: 

• rental income from leases in a BTR dwelling; 
• capital gains on disposal of a BTR dwelling; and 
• capital gains on disposal of membership interests in an entity to an extent the value of the interest is referable to a dwelling in an eligible new BTR development.

The expansion of the types of fund payments which will attract the 15% withholding tax rate to include capital gains was the result of public consultation on an exposure draft of the Bill and is consistent with other MIT holding tax rate concessions announced last year. It responds to stakeholder criticism that foreign investors would be deterred from investing in BTR developments due to a lack of clarity regarding the tax repercussions to their exit strategy. 

Eligibility

To access one or both concessions, a BTR development must meet all of the following:

1. capital works on the development begun after 7:30pm AEST 9 May 2023;
2. include 50 or more residential dwellings made available for rent to the general public; 
3. the dwellings must be offered for lease of at least 3 years (unless a shorter term is requested by the tenant); 
4. 10% of the dwellings must be offered as "affordable tenancies" (defined as rented for 74.9% or less of the market rent for comparable dwellings). This 10% must be across all types all types of units, such that affordable housing units cannot just be one bedroom apartments if the development also has 2 and 3 bedroom apartments available. The aim is to prevent a BTR owner from allocating only the lowest standard dwellings in a development as affordable dwellings; and
5. all dwellings and common areas must be owned by a single entity for at least 15 years (although the BTR development can be sold to another single entity during the period and remain eligible for the concessions).

BTR developments can also include new builds as well as substantial renovations that convert existing buildings (eg. warehouses) into rental dwellings. 

Other comments

The BTR Bill currently restricts access to the 15% withholding concessions where eligible fund payments flow through a tiered trust structure. Where fund payments are made by an MIT from an intermediary trust, the MIT, the intermediary trusts and the BTR development owner must have the same trustee. This is a technical issue with the current drafting of the BTR Bill. 

15 year compliance period

The BTR Bill requires the owner of a BTR development to opt in to the concessions, which requires the owner to specify when the relevant criteria are met and the BTR compliance period commences. 

However, even beyond the 15-year BTR compliance period, the tax concessions will continue to apply as follows: 

• accelerated capital works deduction: even if the BTR development ceases to meet other BTR criteria, it continues to be eligible as long as the single ownership criterion remains satisfied; and
• withholding tax concessions: for as long as a BTR development continues to meet each of the criteria above and therefore remains an active BTR development. 

The removal of the 15 year limit on the BTR tax concessions since its introduction in the initial exposure draft is a welcome development.

This is because BTR development are capital intensive up front, and therefore, BTR owners are practically only likely to receive the benefit of the concessional withholding tax rate on rental income in the last years of the BTR compliance period. The ability to access the withholding concessions even after the 15 year period is over (subject to continued satisfaction of relevant criteria) should both incentivise investors and also maintain the value of the asset to subsequent investors. 

Imposition Bill

The purpose of the Imposition Bill is to ensure the integrity of the tax incentives by enforcing a "misuse tax" upon taxpayers who improperly claim the concessions, which impose significant penalties if the building ceases to be an active BTR development within 15 years. It will neutralise any tax benefit received. This is done by amending prior year tax returns to impose a BTR development misuse tax equal to the tax benefit gained increased by 8%, which represents interest and costs associated with the tax shortfall. 

Senate’s recommendations

The Senate Committee have recommended that the Bills be passed. There is no mention that the Bills be passed with technical amendments or that they be passed unamended in its recommendation. However, the Senate Committee does note in the body of the Report that it is pleased that Treasury is continuing to work with stakeholders who structure their businesses using sub-trusts to clarify the application of the BTR incentives. This suggests that the Bill may be amended prior to being passed.

Further, the Coalition, Greens and independent senator David Pocock provided dissenting comments or recommended the Bill be passed only if changes were made to the Bills.

Compare this to the recently enacted amendments to the thin capitalisation provisions which were also referred to the Senate Committee prior to becoming law. In the case of the thin capitalisation amendments, the Senate Committee’s proposals led to a further round of exposure draft legislation, and the legislation did not receive royal assent for approximately 10 months.

This suggests that the timing of the BTR Bill’s passage is uncertain, particularly in light of the dual-trust structure amendments that are required to ensure that the concessions can be accessed by the relevant stakeholders.

State BTR tax concessions

In addition to the Bills, the majority of Australian jurisdictions have introduced concessions to facilitate BTR investment. Each State’s position is outlined below.

New South Wales

Concessions: 50% reduction in land value for land tax calculation purposes and exemptions from and refunds of surcharge purchaser duty and land tax in force from 2021 tax year until 2040.

Eligibility: set out in the Treasurer's Guidelines and Revenue Ruling G 04, which notably include requirements that:

1. construction started on the land commenced on or after 1 July 2020;
2. provide at least 50 self-contained dwellings which are constructed or substantially renovated for the purpose of being occupied under residential tenancy agreements;
3. managed by a single management entity and held within a unified ownership structure, which can include a group of entities holding joint ownership;
4. comply with any relevant affordable housing policies that may be imposed under the Environmental Planning and Assessment Act 1979 (NSW);
5. dwellings must be offered for lease of at least 3 years (unless a shorter term is requested) to the general public; an and each tenancy must be subject to a Residential Tenancy Agreement under the Residential Tenancies Act 2010 (NSW); and
6. a minimum of 10% of the labour force hours spent on the construction of the BTR must involve or have involved work performed by apprentices/trainees, long-term unemployed workers, workers requiring upskilling, workers with barriers to employment (eg. persons with a disability), Aboriginal or Torres Straight Islander job seekers and graduates.

Victoria

Concessions: 50% reduction in land value for land tax calculation purposes and exempt from land tax absentee owner surcharge, in force from 2022 tax year for up to 30 years (provided that the development continues to satisfy the eligibility criteria for a continuous period of at least 15 years). 

Eligibility: 

1. the dwellings must have an occupancy date (i.e. when the dwellings are first suitable for occupancy as evidenced by an occupancy permit) on or after 1 January 2021 and before 1 January 2032; 
2. provide at least 50 self-contained dwellings which are constructed or substantially renovated for the purpose of being occupied under residential tenancy agreements;
3. managed by a single management entity and held within a unified ownership structure, which can include a group of entities holding joint ownership; and
4. dwellings must be offered for lease of at least 3 years (unless a shorter term is requested) to the general public. 

Queensland

Concessions: 50% reduction in land value for land tax calculation purposes, 100% reduction for land tax foreign surcharge in force from 2024-2025 tax year until 30 June 2050 or for a maximum of 20 years, whatever comes first. 

100% discount on any additional foreign acquirer duty (AFAD), available for relevant transactions entered into or after 1 July 2023. 

Eligibility:

1. become operational (ie. suitable for occupation) after 1 July 2023 and before 30 June 2030, and meet all of the eligibility requirements by the end of the second full financial year after becoming operational;
2. provide at least 50 self-contained dwellings which are constructed or substantially renovated for the purpose of being occupied under residential tenancy agreements;
3. managed by a single management entity and held within a unified ownership structure, which can include a group of entities holding joint ownership; 
4. 10% of dwellings as affordable housing at discounted rents (i.e. at least 25% below market rents of similar dwellings in the BTR development) to eligible tenants for the 12 months prior to the relevant 30 June;
5. in respect of the land tax concessions, have maintained eligibility continuously, regardless of any changes in ownership of the land; and
6. in respect of the AFAD relief, maintain eligibility for the land tax concessions for at least five consecutive years and not transferring or subdividing the land before the tax concessions have been obtained for the required period of time.

Western Australia

Concession: 50% reduction in land value for land tax calculation purposes for up to for 20 years, in force from 1 July 2023.

Eligibility:

1. the dwellings in the development are able to be lawfully occupied between 12 May 2022 and 30 June 2032 and become occupiable within five years of each other;
2. provide at least 40 self-contained dwellings which are constructed or substantially renovated for the purpose of being occupied under residential tenancy agreements;
3. dwellings must be offered for lease of at least 3 years (unless a shorter term is requested) to the general public; 
4. managed by a single management entity and held within a unified ownership structure, which can include a group of entities holding joint ownership; and
5. the land consistently qualifies for the relief for a period of at least 15 years. Where the land ceases to qualify for relief during the first 15 years of it being applied, the Commissioner will retrospectively apply tax for the years the land received the concession (if land becomes ineligible for the exemption after the 15th year, the land will no longer be entitled to the exemption but retrospective land tax will not be applied).

Where parts of the BTR are used for non-residential accommodation purposes (such as commercial activities) the exemption will be proportionally reduced.

South Australia 

Concession: 50% reduction in land value for land tax calculation purposes, in force from the 2023-2024 land tax year up to (and including) the 2039-2040 land tax year.

Eligibility:

1. construction of the building commenced on or after 1 July 2023;
2. dwellings must be offered for lease of at least 3 years (unless a shorter term is requested) to the general public; and
3. any other requirements prescribed by the regulations are complied with. 

We note Revenue SA as at the date of this article has not yet released specific provisions with respect to the minimum number of dwellings and affordable housing requirements. 

Tasmania, Northern Territory and the ACT are yet to introduce any concessions. 

Insights

Lowering the MIT capital gains tax to 15% is a good start. It gives investors clarity on the tax implications of their investment exit strategy and will facilitate the required capital to develop BTR projects and is a win-win for both government and foreign investors.

However, the Bills in their entirety are not sufficiently concessional to have the desired level of impact. In order for the Policy to achieve its objective of “supporting investment in new housing stock” including through “investment in Build to Rent developments" the Bills should be more concessional and the criteria to access its incentives should be less onerous.

If this does not happen, foreign capital will continue to look to more laissez-faire, low risk, established BTR markets (such as the US and UK) where there is less risk associated with return on investment.

It is also notable that there are no proposals to address key GST issues which could drive domestic investment in the BTR sphere.

Outlined below are some recommendations gathered from across the industry that, if implemented, may facilitate foreign investor appetite for the Australian BTR market.

Industry recommendations for the Bills

Retrospective application

While acknowledging that the reasoning behind the incentive being available to new BTR projects is to encourage BTR development, the Bills (in their current form) will have a prejudicial effect on investors who were early entrants in the market and deter them from aligning with the desired policy.

In short, if existing BTR investors cannot access the concessions, why would they want to offer prospective tenants affordable housing or the security of longer-term tenancies? 

Per the PCA Report there are approximately 23,000 residential dwellings that fall into this category. If the concessions are not applied retrospectively, both current and future tenants will not have the security of a long-term tenancy, nor the opportunity to access affordable housing. 

Additionally, investors who cannot access the concessions will be forced to compete with investors who can, creating a considerably uneven playing field. The BTR assets that are not eligible will become "stranded" (inferior to new developments on the basis of profitability) and be harder to sell, making investors’ exit strategy less profitable. 
This will inevitably trigger an increase of rent from these BTR operators to keep up with operators who can access the concessions which in turn, will adversely affect rental affordability – the precise opposite of the Bills’ rationale.

The Government may consider applying the concessions retrospectively to BTR developments that are currently operational and commenced capital works prior to 9 May 2023.

Housing affordability requirements

The inclusion of affordable housing is a necessary component to achieve the social objectives of the Bills. However, the requirement of 10% of the BTR development to rented at 74.9% or less of the market rent for comparable dwellings will erode more than half the advantage of lowering the MIT tax concessions to 15%. This may deter BTR investors from investing as the perceived return on investment will not be as lucrative as first modelled. 

Reduction of the final withholding tax rate

While the proposed withholding tax rate changes align the tax treatment of BTR investments by MITs with some classes of property assets, it is still at odds with other assets classes. For example, an MIT that holds only certified "clean buildings" is eligible for a reduced rate of withholding tax of 10%. Given the critical undersupply of housing, there is widespread consensus that BTR should at least be on an equal footing to incentivise investment.

The Government may consider lowering to MIT concessions to 10% or better still, 5%. This will not only offset the loss of rental yields (from the requirements of 10% affordable housing) but also send a market signal of support which will accelerate an Another option could be to scrap the housing affordability requirements all together, which would remove the need to lower the MIT concessions. This could (with investor incentive to construct more dwellings) naturally create more housing supply and lower rental prices. Modelling by EY, commissioned by the Property Council of Australia last year, shows that implementing the 15% withholding tax without the 10% affordable housing condition, could lead to the creation of 150,000 apartments by 2033. With rental vacancy rates a record new low of 0.7% it with a clear downward trend seems like time is not on the Government’s side and every pro-investor policy counts.

Restriction on access to withholding concessions in a tiered trust structure

Tiered trusts are a common way to structure real estate investments, which is in part because it assists to obtain financing at the appropriate level without the need to provide security. Usually, the asset or project trust that is the BTR developer or owner will not be a withholding MIT itself. The requirement that the head trust and the wholly-owned BTR owner have the same trustee would mean that, these entities would be collapsed into a single trust. This requirement will likely significantly limit the class of investors for whom the withholding tax concessions are available. The EM provides that this change has been put in place to simplify the administration of the BTR Misuse Tax. However, we consider that this feature of the BTR Bill is likely to be a disproportionate solution to the issue of administering the BTR Misuse Tax. 

In relation to this, the Senate Report noted “the committee is pleased that the Treasury is continuing to work with stakeholders who structure their businesses using sub-trusts to clarify the application of the BTR incentives.” 

Accelerated capital works deductions

This measure will ultimately shorten the period over which construction costs of eligible buildings are depreciated (from 40 years to 25 years), thereby enabling investors to benefit from larger deductions each year. While a welcome change, it is unlikely that the accelerated depreciation benefit would be sufficient enough of a driver to attract domestic investors to participate in consortiums with foreign investors.

Interaction with Australia's Goods and Services Tax (GST) Regime 

One of the primary obstacles facing BTR initiatives are the challenges associated with GST. Under the current regime in Australia, supplies of residential premises by way of lease are input taxed. This means that GST is not levied on the rent charged. However, it also means that developers and operators are unable to claim credits for the GST included in the price of expenses associated with making those supplies, such as land acquisition, construction and other development costs, and repairs and maintenance on the premises. As such, there will be a 10 per cent leakage of GST. At this stage, there have been no proposals to introduce any GST concessions or exemptions for BTR projects but allowing developers to claim GST credits would enhance the viability of BTR projects. While the proposed changes may incentivise foreign investment into BTR and the GST leakage can be somewhat mitigated with proactive and effective structuring, a change to the way GST is treated would further contribute to both foreign and domestic investment into the sector. With a growing funds management and superannuation sector in Australia, it is disappointing that GST changes have not yet been adopted.