Richard Carmont
For me, the single biggest impediment at the moment is the delivery risk in construction prices, so we've had cost escalation in construction over the last three years of circa 40, 45%. The reticence to take on development exposure from investors is really about the risks of delivery, and I think that's one really big challenge at the moment that we're all facing. Policies to incentivise things to happen. Given enough government incentives, the private sector will deliver, I believe.
Kathryn House
Australia's emerging build to rent sector remains in the spotlight, with the need for housing having never been stronger. BTR is a well-established asset class in the US and the UK, where it's known as multifamily. And it's been touted as one part of a bigger solution for Australia's housing crisis. Regular Talking Property listeners might recall our first BTR Talking Property episode last year. We chatted to Mirvac sector lead, Angela Buckley, about the keen interest in this market sector, which involves blocks of apartments that are purpose-built and designed as long-term residential rental accommodation, which is predominantly owned, managed, and operated by an institutional investor for a long-term investment period. However, since our last episode, the trading environment has been challenging. It's been a tough year to get new projects started, with government policy issues, delivery challenges, high interest rates, and a constrained capital markets environment. So, what does the future hold? What's needed to accelerate Australia's BTR rollout? And what are some of the lessons that have been learnt by Australia's BTR pioneers? I'm Kathryn House, your Talking Property host, and to give us the lowdown, I'm joined by Richard Carmont, the chairman of Arklife and a board member of ADCO, one of Australia's largest builder developers. ADCO has been at the vanguard of Australia's BTR evolution through its 50% stake in Arklife, a homegrown, Brisbane-based BTR group formed in 2018. Thanks for joining me, Richard.
Richard Carmont
Pleasure, Kathryn. Lovely to be here.
Kathryn House
I'm also joined by the Pacific head of CBRE's Living Sectors Capital Markets business, Andrew Purdon.
Andrew Purdon
Hi, Kathryn. Great to be back and to talk to you both.
Kathryn House
Fantastic. Richard, ADCO was one of the first Australian groups alongside Mirvac to dive into BTR. Being an early mover has clearly paid dividends, with two of Arklife's projects recently sold to the $256 billion Ontario Teachers’ Pension Plan and the US-based Hines, the world's second largest build to rent player. So before we get into some of the stickier questions about Australia's BTR sector, I'd love to take a bit of a step back to hear more about ADCO and how Arklife came to be. I hear you were a little skeptical initially about the whole BTR concept.
Richard Carmont
Yes, Kathryn, I was. I mean, you've got to look at... Well, I live in the eastern suburbs of Sydney and our projects are all in Brisbane. So when we were first contemplating them, I came from an environment where rental yields are 1 to 2%, and so I was a little skeptical in our ability to get the yields that would make it commercially viable. But I guess it was a different market in Queensland and particularly Brisbane where we are. And the actual passion for it within our group came from Scott Ponton, who's our Managing Director of Arklife. Scott was working for us at ADCO development managing a build to sell project that we were doing, luxury apartments on the river at Bulimba. I was traveling up from Sydney for that project regularly with Scott. And whilst we were delivering that project, he kept pitching to me the concept of build to rent. And again, I did start off fairly skeptical, but to Scott's credit, he worked away, he persevered, he pitched the model to both myself and the other ADCO directors. And we got to the end of that build to sell project. We had a little bit of residual stock and we decided to rent one or two of them. And I was just really shocked at how strongly they rented, how quickly they rented and the yield that we're getting. And that sort of backed up Scott's thesis that different environment in Brisbane, it potentially could work. And then that flowed on to working the model of Robertson Lane, which we eventually bought and completed.
Kathryn House
So it's clearly been a bit of a journey. I know you initially went up to Asia to try and get some capital way back when. How did that go? It was really at the early stages.
Richard Carmont
So having got enthusiastic about the BTR concept, Scott and I thought, we'll set up a platform and we'll raise external institutional capital. Very similar to what I think a lot of people are trying to do now. And it wasn't a lot of people doing it then. We're definitely an early adopter. So we traipsed around Hong Kong and Singapore talking to the big investment houses over there, but we didn't have any luck. We had interest without commitment and that was a little bit disappointing for us because by that time I shared Scott's enthusiasm about the BTR concept. We had a few sites that we had in mind, but what we needed was the capital. So, fortunately on the ADCO side, ADCO has been a long-term successful construction business and it's a family business with a bit of an entrepreneurial spirit. And from time to time we've invested in opportunistic investments, be that development. We've got a marina and shipyard, tourist attraction down in the Tweed. So, Judy Brinsmead who's the owner of ADCO, she is open to strategic investment. So we pitched the concept to Judy about, well, let's use ADCO's internal pool of capital to get our first few assets going, and then perhaps we can go and reengage with the institutional investor market once we've proved our model. And that's what we did. And that ended up driving the development of both Robertson Lane and 17 Cordelia, which we've just recently sold to Hines and OTPP.
Kathryn House
So that skin in the game, does that make you a little different to some of the other players out there?
Richard Carmont
Well, I think it does. The ability to control your developments both financially and from a delivery point of view, I think is a distinct advantage and particularly at the moment where delivery is a challenge. Our timing with our first project was pretty good, so we finished that in 2021, so we had a different cost base. The building environment was a lot easier than it is now. But certainly with a larger project, 17 Cordelia Street, I think the ability to have your building arm managing and controlling that, particularly in a difficult building environment, was one of the reasons that we had the confidence to actually start the project. And I think that's been a pretty good decision in the end.
Kathryn House
And then you've brought in Andrew to look for capital once again leading to the Ontario and Hines deal.
Richard Carmont
So our original knockbacks, we thought, well, okay, we've gone out and we've proved ourselves, because the two deals that we completed were deals that we presented to investors. And ironically, quite a few of those investors that we presented to five or six years ago were in the data room looking at the product now that had been completed. So Andrew assisted with that, and I think, the global reach of CBRE and just the experience of formality of the process, which we didn't have a huge amount of experience with, to be honest. So we put our trust and faith in the CBRE team who ran the process for us, which was a very interesting process. It just highlighted lots of interest in the sector and it led to Hines and OTPP being the preferred party, and we've recently closed the deal out with them.
Kathryn House
So Andrew, from your side of the fence, what was that interest like? Obviously it has been a bit of a tougher environment. What did you find, what was the feedback from the buyers that you were talking to and how did that process run?
Andrew Purdon
Well, when we took the brief on, Kathryn, we made a commitment to Richard and Scott and the ADCO shareholders that we would engage globally with this opportunity. And the reason for that very simply is that what the team had created in Brisbane was very, very rare. And Richard's a humble guy, but they've speculatively developed a building. They'd leased it during COVID. They proved up an operating model, built a brand, and then of course that building being more of a pilot-scale, building 89 apartments in Fortitude Valley, then was a stepping-stone into doing the next building at Cordelia Street, which is much larger, 265 apartments. So, what we were able to showcase to investors was that this group had been there and done it and created the real estate. We weren't selling a pitch deck or a load of beautiful CGI's. We were selling real real estate, which attracted interest from all over the world. We had interest from a few domestic investors, superfunds but they were a little bit conservative on pricing. And actually, Richard, I was reflecting on it before this recording, we had people flying down from Asia to meet you, and we had some European investors flying in as well. I remember we had a few dinners with some Europeans who'd flown in from north west Europe to meet and to understand the opportunity. So, I think given the state of where the market is and the understanding that to access the sector in Australia to get built product is really, really hard, combined with the proven track record that ADCO and Arklife delivered. It was very well received in the market despite the challenges in the capital markets.
Kathryn House
So by the sounds of it, you're finding that the offshore capital is a little bit more competitive than the domestic market at the moment?
Andrew Purdon
Not always, but I think what quite a few of the overseas investors have, they have more experience in the performance of the assets. So when we talked about occupancy levels, rents, rent growth, that sort of thing, they're drawing upon more experience from other markets. There are some very, very well-established domestic investors who have exposure to BTR in Australia. But when we're presenting these types of opportunities, we do find, generally speaking, that the overseas investors come to the top of the pack when it comes to the bid pricing.
Richard Carmont
The thing for me was that a lot of these overseas investors have been doing it for 20, 30 years. And I think the newness of the product in Australia, from my perspective, seemed to create a little bit of nervousness in jumping in from the Australian institutions. But the overseas institutions, I really enjoyed meeting them when we... As Andrew said, we had people come from Germany, from New York, from Japan. We met people from all over the world. And it was really interesting for us to see the depth of experience, the depth of that investment market right around the world, who were very familiar with the build to rent style product and had been doing it for a long time. I think that probably was the slight difference for me. Hopefully as the market evolves in Australia, the onshore institutions get more comfortable with it, and I think they certainly have the ability to be competitive because they have a more favourable tax environment. I think it's probably just getting comfortable with the profile of the investment.
Andrew Purdon
I think that's a timing point, Richard, isn't it? The Aussie domestic investors, they seem to want to see more proven evidence of investment performance so that they can underwrite with more confidence. Whereas the overseas investors, as you say, because they've been doing it so long, they're drawing parallels from their home markets or other markets they're invested into, and they arrive at very similar assumptions to those that the likes of CBRE put into our modeling.
Richard Carmont
Yes, absolutely.
Kathryn House
So what is it that they like about Australia? So why invest in BTR here as opposed to in other markets?
Richard Carmont
From my perspective, and if I'd zero in on the Brisbane assets as where we've sort of specialised, I mean the market fundamentals are brilliant from an investment point of view. When you look at the demand side, you've got a real supply shortage. And it's the same reason that we got into it ourselves. If you look at the growing rental demand, the population growth, the low vacancy in the Brisbane market, and then you look at the supply, and the supply is really, really thin. And it takes three to four years to deliver a reasonable sized build to rent asset from concept to completion. So the supply is not going to catch up in a short space of time. So I think the overseas investors look at the demand supply dynamics in Australia, and Brisbane particularly where we were doing our transaction, and it's very, very compelling. And add to that, you've got an advanced country with a good rule of law, all those sort of things that make Australia an attractive place to invest. I think it's a very, very compelling argument to invest in Australian BTR.
Kathryn House
And so what's next? You talked about Brisbane, but I understand that you're looking to broaden your horizons following the Hines and Ontario deal.
Richard Carmont
We're working on two more projects at the moment, both a Queensland-based one and the Gold Coast and another one in Brisbane. So our immediate priority is to try and get those projects underwritten and going. And Andrew is assisting us with one of those. That would bring our number of apartments under management in Queensland to just a tick under 1,500 apartments. And so if we can achieve that as our immediate short-term goal, the next stage would be geographical expansion and probably along the same lines as the locations of the ADCO business. ADCO is a strong eastern seaboard business with offices in Brisbane, Sydney and Melbourne, and an office in Perth as well. And they're probably the key markets that we would see longer term that Arklife would target as well. Again, that's subject to capital availability, partners, etc. So we'd like to see the market evolve and the institutional partners increase, and hopefully that will assist our rollout through both a few more projects in Queensland and geographically expanding in Australia.
Kathryn House
So we've talked about the strong fundamentals for the sector, but it has been on a little bit of a go slow this year. And this is a question for both of you. What do you think is really needed to propel the BTR sector more quickly in Australia? Obviously there's been a lot of talk about some of the government policy settings. Andrew, what are your thoughts there?
Andrew Purdon
Well, from a macro perspective, Kathryn, the environment has been quite tough this year. And let's start with the interest rate environment. There's been a lot of commentary around whether we're at the peak of interest rates in Australia. We all certainly hope we are.
Kathryn House
I hope we are.
Andrew Purdon
We hope we are, and we seem to now... We're definitely seeing evidence around the world that other major economies are tapering the interest rates downwards. But when we're in that sort of, are we dropping, are we not dropping environment, investors tend to sit on the sidelines a bit and wait and see. We talk about those as being cyclical issues. And one of the big trends in a challenging down cycle is that many investors are dealing with revaluations of existing assets. Probably the bigger food groups in Australia being offices, retail’s recalibrated quite a lot in terms of cap rates. Industrial has moved out a bit. So investors are a bit distracted by those sorts of things when they've got exposure to different types of real estate assets. And then the other characteristic of a more challenging cyclical environment is that development tends to fall down the priorities for a lot of investors. And that's not unique to BTR. In challenging environments investors tend to gravitate towards income producing stock rather than building new. So look, we see that as a short-term issue that as Richard alluded to, the demand drivers in Australia are very, very, very strong and investors globally recognise that. But we've had a bit of a pause this year for some of those cyclical reasons. But on the structural side, I mean the government really does need to land on a clear policy position on tax for the sector, which is specifically related to overseas investors, and needs to find a way to really lever in and incentivise the delivery of housing. I know Richard is very passionate about this. I just think, well, as am I, that the government needs to think bigger and bolder around how they're going to increase supply rather than getting stuck in inter- party debate and a sort of plodding nature of policy formation to actually get on with bringing in the capital. Because at the moment the policy settings are not clear for investors. And again, it forces people onto the sidelines.
Kathryn House
Richard, dare I ask your view.
Richard Carmont
Well, for me, the single biggest impediment at the moment is the delivery risk in construction prices. So we've had cost escalation in construction over the last three years of circa 40, 45%. The reticence to take on development exposure from investors is really about the risks of delivery. And I think that's one really big challenge at the moment that we're all facing, cost delivery and risk of delivery. And then as Andrew just alluded to, I think policies to incentivise things to happen. Given enough government incentives, the private sector will deliver, I believe. I believe there's enough sites. I believe there's the ability to do it, but we've got to make the feasibilities viable. I think in a lot of cases, particularly with affordable, it needs a little bit more incentives and government support. So I think it's a multiple overlay. I think there's some policy decisions that could help us. A bit more stability in the costs and the risks and delivery, I think are absolutely critical. But I think until we solve those problems, I feel like it might continue to be a little bit slow in terms of new projects.
Kathryn House
That affordable piece is really interesting as well. What could be done to encourage more affordable elements within BTR. Andrew, you were talking the other day maybe about government supplying land in some cases, which would make it more feasible.
Andrew Purdon
Well, I think most BTR groups are in the same camp on this in the delivery of affordable, as long as the type of affordable is compatible with the rental housing. So if we can think about affordable in this context as rental discounted market rent type affordable, most of the groups are very, very supportive of the inclusion of those affordable units within the projects. But the reality is that they need a financial incentive to actually make them viable because they are worth less on completion those units than they cost to build. So there's no point trying to force the affordable into a project to make the whole project unviable. That doesn't get supply delivered. And as Richard said, the feasibility is because of the construction costs plus the capital environment we're in, interest rates and financing rates. The feasibilities are already quite thin in some instances. So to lever in then affordable on top of that, pushes many projects into the unviable bucket, which is the opposite of what we should be doing when everyone accepts we need so much more supply delivery in Australia.
Richard Carmont
When you think about it from an operator's point of view, it's a pool of customers there. So if we can have that, even at cost neutral to our fees, you would love to have those customers in your building. So we're enthusiastic about it, but it's just that financial piece that is still not quite there.
Kathryn House
So that's probably a good segue into talking about the customers in your building, and a little step back just to give people a bit of a, I guess an aerial view of what your projects look like. So Robertson Lane, very successful. Talk us through how quickly that was leased up and the types of renters that you do have in that building.
Richard Carmont
It was leased up very quickly. I think we had something like 50% of the building leased before we finished, and then it was 100% leased within three or four months. So it's been a very successful project. The mix of people in there is quite interesting and its sort of evolved a bit because we had to go through COVID. Even through COVID, we had very high occupancy, but obviously there was no interstate movement or overseas movement. So the COVID cohort was Queensland and local. Since the end of COVID, the mix has really evolved. Young professionals. It's very popular with young professionals and always has been. But a lot of international people, people moving over for jobs, moving to Brisbane and moving into build to rent, I mean, people who are not looking to buy, they just want to rent an apartment, it's an easy step for them, particularly on our furnished apartments. We've got some students. We've got some level of interstate migration. So it's really evolved to quite a mix. We've got families because we have a high percentage in that building of three-bedroom apartments and a lot of those are occupied by families. So it's quite a diverse mix. I think the thing that we’re really happy about that building ,part of our ethos is to develop a community in our buildings. And I think that has really worked in terms of a real community. There's a diverse group of people. The social functions are really well attended. We have resident functions every month or two. People have become friends. They've got to know each other. So it's been a great success in that sense as well as it's leased up really well. Its vacancy rates have been really low, and I think that probably one part of that is the amenity, the gym, the rooftop pool, all those sort of things that perhaps aren't available in some other buildings. So I'm really proud of that building. I know Scott and the team are very proud of it as well, and the ADCO board. Whilst it was a smaller project, I still think that's probably one of the best BTR examples in Australia.
Kathryn House
And you talk about amenity. We were having a chat the other day about, you did a bit of a world tour, so to speak, and what you saw with other BTR projects in, say, the US and other markets, that there's been a bit of an amenity arms race and the whole idea of furnished versus unfurnished apartments. What were some of your real learnings from overseas in that regard?
Richard Carmont
Yes, well, it's sort of interesting in different markets. The London market was interesting in the sense, a similar sort of size of apartments and layouts and probably amenities to what we were doing. And I think the concept of furnished versus unfurnished, a lot more furnished product in London. And a lot of the groups were pushing into a greater proportion of furnished units, which is our model in a sense. We get about 60% furnished, so we're the largest proportion of furnished units of the Australian BTR operators, and we do find that they're popular. And that was some of the learnings from London. In New York, I talked about the amenities’ arms race. Some of the amenities in the new buildings over there were just unbelievable. I suspect that's very difficult now. I mean, New York, London, everywhere has the same issue with building costs as we do over here. So I think there will be challenges in putting that level of amenity into future buildings. They had full basketball courts in the basement, squash courts, pools, green screen rooms for the actors, giant gyms, all sorts of stuff. Tennis court, underground tennis court. So incredible facilities. Although the one thing they don't have over there is parking. We obviously have our basement parking here. But I think that is going to be increasingly difficult for everyone in the new cost environment. Having said that, your amenities, even with our buildings, that's what differentiates our product from rival products. If you're looking to move into one of our buildings, you're probably pricing your gym membership that you don't have to spend because-
Kathryn House
I hadn't thought about it like that.
Richard Carmont
Well, and that was a lesson when we spoke to the States. And in the States, what they were doing, a lot of them were charging extra for the amenities, or the ones that did include it, but that was part of the sell. Well, you've got your rent here, but you're going to save a hundred bucks a month on a gym membership because we've got a great standard gym. And that's a similar thing for what we're doing. The health and wellness is a big part of the Arklife offer and you'll see oversized gyms in all our buildings, but that's sort of one of the sells. Rolled into that rent that you have with us is access to a great gym, which is save on your gym membership. So the amenity is important. Brisbane, obviously a nice pool. We've got rooftop pools on our buildings. Cordelia has a 25-metre lap pool on the roof. Resident lounges, private dining rooms, things like that. I think they're a point of difference from alternative buildings that probably justify our occupancy and maybe a slightly higher rent.
Kathryn House
So we've talked about the two Brisbane projects, which have already been sold. You do have 50 Constance Street. It's approved, but still a site at this stage. Why do you think that's going to be appealing to investors also?
Richard Carmont
I think this is a potentially great development. As you said, it's council approved, 327 apartments in a great spot in Fortitude Valley. And I think from our point of view, we feel that our model where we've proved the BTR in Queensland, we've delivered a number of projects, and we're looking for a partner to work alongside us to deliver this next project. I mean, what makes us different I think is the end-to-end service that we provide. And we've got the construction company and the ability to deliver it, which is probably the most difficult part of the development process at the moment. We've also got the Arklife team who can development manage, design manage, and then manage the leasing and property management at the end of it. So there's very few groups who are that vertically integrated. And I think that sort of ticks a lot of boxes in terms of what Andrew was talking about earlier in the reticence of investors to take on development exposure. We're in a position where we can diminish that risk and deliver an outcome because of the unique skills that we have between the organisations of Arklife and ADCO.
Kathryn House
Well, thank you so much for joining today, Richard. It was really fascinating to hear how your group has evolved. It will be really interesting to see your next plans and hopefully we see the construction environment becoming a little more friendly in the future.
Richard Carmont
Yes. So do I. I think construction is starting to stabilise, which is good after three horrific years. So hopefully that's one of the ingredients to get more projects going in the next two years.
Kathryn House
Light at the end of the tunnel.
Richard Carmont
Yes.
Kathryn House
And thanks too for joining, Andrew. It will be very interesting to see how the sector plays out, particularly with these new models evolving. So things like co-living and single-family housing. So I think it's going to be an exciting period ahead for the build to rent sector.
Andrew Purdon
I agree, Kathryn. And it is an exciting time when things get tough like we are in at the moment, both capital markets and delivery. It forces innovation. So we're in an innovation stage and I think we'll see some really interesting things happen over the next six to 12 months.
Kathryn House
To our listeners, thanks for tuning in and make sure to follow Talking Property so you don't miss our future fortnightly episodes. We'd also love for you to rate or review the podcast to help spread the word. And if you have any feedback, you can drop me a note at any time by
[email protected]. Until next time.
