Last month, the Federal Minister for Housing, Tanya Plibersek, stood up in the Sydney boardroom of JPMorgan and attempted to do something which has been tried, unsuccessfully, many times before. She was appealing to institutional investors to consider residential property. Specifically, Plibersek was asking them to get behind the National Rental Affordability Scheme (NRAS), which is offering Government subsidies to developers of housing deemed ‘affordable’ – that is, rented out at 20 per cent below market rates. There are special allowances for major institutions (Plibersek has singled out super funds) willing to back major developments of 1000 or more sustainable dwellings. Veteran property consultant Ken Atchison has seen such attempts to sway institutions before, and he doesn’t think the NRAS has solved fundamental problems which have kept them away to date. “The biggest problem is how you assemble a portfolio.

The rental property market in Australia is worth $1 trillion [similar to the ASX] but where it’s very easy to buy a diversified portfolio of shares, it’s very difficult to get the same scale with residential property. There’s also the issue of how you manage the very high transaction costs, around collecting rents, managing leases and the like”. Atchison says his consultancy has worked with “at least a dozen groups who’ve looked at residential investment and have wanted to find a way to do it, but have been stopped by these portfolio and cost issues”. The veteran consultant also says he’s encountered the view among stakeholders at some institutions that residential property “is not really an investment but about providing individual utility”, a view they have transposed from their on personal experiences. The industry funds would seem natural backers of the NRAS, chiming as the scheme does with the funds’ generally strong support for socially responsible investment.

However head of the property group at industry fund-owned Frontier Investment Consulting, Jonathan Stagg, says the high cost leakages are not the only obstacle to direct investment in residential accommodation. “Super funds face the problem of competing for assets with private investors, who have the significant advantage of being able to negatively gear their interest repayments,” he says, pointing out this uneven playing field is less of a problem in the large commercial transactions traditionally preferred by super funds. “Also, do your members really want to be competing at an auction with their own super fund, bidding on the same property? You can imagine some pretty horrible outcomes from that scenario.” The equity alternative Direct ownership is not the only way into residential property being offered to institutions. Some institutions have stood behind the reverse mortgage or ‘equity release’ mortgage market, which in Australia now has $2.6 billion of loans outstanding, to homeowners with an average age of 74, according to Deloitte’s latest study of the market.

An alternative which may be on the radar of younger members is the ‘shared equity’ or ‘equity finance mortgage’, as exemplified by Rismark International via the loans it distributes through Bendigo Bank and Adelaide Bank. The $50 million invested with Rismark so far (by those same two regional bank distributors) has been spent on around 500 different homes in metropolitan areas around Australia. Eschewing the traditional direct ownership model, Rismark loans are for up to 20 per cent of a house’s purchase price. Buyers never pay interest on the loan, rather they repay the original principal when they either sell the home or 25 years elapse, plus 40 per cent of the home’s total capital appreciation. If the home’s price has happened to fall, the amount repayable on the original loan will reduce by the same proportion. Rather than the potentially adversarial situation outlined above, “our investors only do well when our borrowers do well”, according to Rismark’s managing director, Christopher Joye.

Based on the cash-flows realised by the repayment of over 60 shared equity assets since its March 2007 inception, Rismark’s portfolio has generated an internal rate of return of around 7 per cent per annum, and reports that its “mature portfolio” mark-to-market value is 21.3 per cent higher than its starting value. “This was despite 2008 being the worst year on record for residential property returns,” Joye says, adding that under the Rismark model, the hurdle of high transaction costs is overcome by the fact that the owner-occupiers meet all of the outgoings, including the stamp duty liability. The ultimate gesture of approval for the shared equity concept has been given by the head of asset consulting at MLC Implemented Consulting, Gareth Abley.

When he bought his last house, he went to Adelaide Bank and took out one of the Rismark-backed loans himself. From the homebuyer’s point of view, Abley says shared equity appealed to him as a hedge against the possibility property prices might fall, because the lender will ‘participate’ in any loss by reducing the amount of their original loan by the same amount as the capital depreciation. As to why his institutional clients have so far not taken the other side of the trade, Abley suspects that “duplication of exposure” is a sticking point, as is also the case with direct ownership opportunities like the NRAS. Not only do the statistics suggest that 70 per cent of any given fund’s membership will already own or be paying off a house, Abley says residential housing is “questionable” as a diversifier because it entails a “broad exposure to the Australian economy already reflected in the Australian equity exposure… you risk exacerbating the home country bias”.

That being said, Abley admits Australian residential property has performed very differently to other domestic asset classes, aligning himself here with Ken Atchison, who says the very fact many people don’t consider residential property an investment creates inefficiencies in the market which canny professional investors can exploit. Atchison is encouraged by the fact Rismark has lent almost all of its original $50 million, which proves there is borrower demand for the equity finance model, despite the extra documentation it entails around the origination of the home loan, and if any home improvements are undertaken (homeowners can apply for a credit from Rismark reflecting their efforts to increase the home’s value).

As to why further institutional support has proven elusive to date, Atchison says an investment to back equity release mortgages would “take a huge amount of analysis” for a trustee board in comparison with a traditional commercial property play. He notes that complexity is not exactly flavour of the month among investment committees anywhere. Another slight drawback in comparison to direct ownership of residential property is a hint of “sub-prime syndication risk”, according to Abley, in that the parties valuing the investee houses are not the same as those taking the investment risk. However, Frontier’s Stagg said an advantage of the equity finance model was that it “seemed more like a partnership” between the investor and the homeowner/super fund member, and he hinted that the concept would be revisited in the consultant’s upcoming review of its approach to property.

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