“super funds and other institutional investors have shunned [NRAS], arguing that the government’s forecast of a 9.9% return is unrealistic.”One of the primary problems on the supply-side of the housing market is the fact that local, State and Federal Government taxes and charges have risen at a tremendous rate since the introduction of the GST and now account for around 30% of the cost of bringing a new Sydney house to market (based on HIA data).
This has meant that it is very hard for builders and developers to practically deliver affordable housing stock. Indeed, the burden of taxes and charges today often results in the cost of a new home being well above its market-clearing price. It should, therefore, be no surprise that the supply-side of the market has been unwilling to manufacture significant volumes of new assets notwithstanding evidence of robust underlying demand (as manifest in record population growth and double-digit annualised house price rises in 2009).
Industry participants have long held concerns about the investment integrity of NRAS. One of the main issues appears to be that the circa 9% leveraged IRR that NRAS purportedly provides does seem to meet their hurdles given:
(a) the uncertainty and risk associated with actually achieving this outcome (ie, the NRAS model assumptions, which have been called into question as potentially optimistic); and
(b) the much higher return requirements for new investment strategies, which NRAS will rank as until its payoffs are clearly proven over a multi-year setting.
Ironically, Australia already has a very large private housing investment market, with around 30% of all new finance being historically employed for the purpose of providing rental accommodation.
Rather than dealing with the fundamental supply-side bottlenecks that are stifling the production of new housing (ie, the aforementioned taxes and charges, zoning restrictions, and antediluvian approvals processes), NRAS was conceived as a band-aid solution to the symptoms of these problems. If the Federal Government wants to effectively stimulate new housing investment, it would perhaps be better advised to compel the States to reduce the assorted levies and charges that are discouraging new capital commitments as a trade-off for the much higher-than-expected GST revenues that they have crystallised.
Turning back to the question of NRAS, the AFR highlighted considerable skepticism around the reliability of its returns. In this regard, Garry Weaven, the Chairman of the $20 billion Industry Funds Management (IFM), commented:
“If everyone was convinced that they could get a 9.9% return there would be no problem at all. People don’t think that’s what they can get…the actual returns look pretty thin.”CBUS's property chairman, Mark Ford, concurred:
“We’re like everybody else in the market: we haven’t been able to make it work…The numbers just don’t make sense at the moment.”Another concern expressed by CBUS was the high level of management necessitated by NRAS, which reportedly made it more akin to a business than an investment. In this context, CBUS’s representative remarked:
“One of the things we have to ask ourselves is, as a super fund, do we want to be running a business?”A further challenge faced by NRAS is the fact that Australian super funds are conditioned to enjoying double digit IRRs on their property development exposures in compensation for the high risks that they assume with these investments.
Development assets carry materially greater hazards than the “established” or existing housing stock because new supply tends to come online in areas with, frustratingly, low demand (eg, on the fringes of cities). This is largely due to the fact that it is very difficult to produce new supply in existing urban areas. That is to say, it is far easier to deliver new housing in regions with easily accessible ‘greenfield’ sites and more accommodating zoning ordinances.
Development assets are also frequently located long distances from major labour markets, such as a city’s CBD, and can be poorly serviced by critical government infrastructure (ie, trains, buses, schools and hospitals). In short, the ‘amenity value’ of the new supply is often far lower than the existing stock.
Other complications with development assets include significant concentration risks, wherein large numbers of properties are situated in small and isolated geographic locales (with commensurately uncertain demand prospects). Development holdings do not, as a consequence, provide a useful proxy for the broader $4 trillion residential property asset-class, which would require a portfolio of assets weighted on a market-capitalisation basis throughout metropolitan Australia.
By computing the correlations between residential returns in different States we know that individual States can often perform in a very different fashion to their contemporaries (eg, consider Perth property post 2003, which realised 20% plus growth whereas housing in Sydney and Melbourne stagnated). And within states there can be enormous dispersion in capital growth rates. In order to capture the Australian residential real estate market’s very low volatility of around 3-4% per annum one needs to be able to invest in a nationally diversified holding of assets.
IFM’s Garry Weaven touched on this point in his remarks to the AFR. He noted that while residential housing has ostensible merit as an investment class, the chief challenge is how to scale large volumes of well-diversified assets on a cost-effective basis over time:
“A lot of people have been arguing this, that the actual performance of residential is understated and it’s actually been a pretty good class to be in. Aggregation, obviously, is the trick to it. From an institutional viewpoint it needs to be aggregated into large investable chunks.”
