HA Housing Insights: Tax considerations for tackling the housing crisis with Brian Farrelly, Pitcher Partners

Property LawProperty & FinancialTaxProperty Tax

24 Mar

“We have a tax and duty system that has historically not supported foreign investment into Australian property through additional duty, land tax surcharges, non-concessional withholding taxes, and potential denials of income tax deductions. Therefore, tax incentives in this space are important.”

— Brian Farrelly, Pitcher Partners

The housing crisis remains a critical issue in Australia.

In this HA Housing Insights series, our social and affordable housing team speak with key industry experts – including developers, builders, community housing providers, investors and property and tax specialists – to gain a well-rounded perspective on the challenges faced in delivering housing outcomes and potential solutions.

In our earlier snapshots, we obtained valuable insights from:

Today we sit down with Brian Farrelly, Partner and Executive Director at Pitcher Partners Melbourne within the Tax Advisory Group to hear his views.

Brian supports a number of clients in the property, finance and fund management sectors and works with groups ranging from family-owned businesses through to large multinationals. In the property space, he assists with structuring real estate transactions, including acquisitions, investment, capital raises and financing, restructures and divestments. Brian and his team work with developers, builders, landowners, financers, investors and fund managers, as well as their advisors, in structuring these transactions.

Pitcher Partners is one of the largest accounting, audit and business advisory firms in Australia. With a focus on middle market businesses from family-run companies to renowned industry leaders and iconic brands.

Brian Farrelly
Executive Director
pitcher.com.au

Q. Tell us about the importance of structuring a project correctly and how this can change the financial feasibility of a project.

A. In my experience, being clear on the tax structure and proposed transaction arrangements from the start is fundamental to a successful project. Given the size of these projects, the impact of income tax, GST, duty and other state taxes have a significant influence on a projects IRR, cashflow and overall success.

Where a project is relying on external investors, the importance on structure is more heightened. It can be damaging to a developer or fund manager’s reputation when representations about the potential after-tax returns are subsequently impacted through poor structuring or unforeseen/unbudgeted tax costs.

In addition to the tax cost itself, the costs of poor structuring can also be significant, including legal advice on revised documentation, project and funding delays, managing investor communications and reputation, as well as dealing with the ATO or state revenue offices who continue to increase their focus on this segment.

In the context of tax, the right structure is driven by numerous factors underlined by the commercial objectives of the project and investment strategy. But the most appropriate structure is also impacted by the precise nature of the property, the structure and preferences of joint venture parties, the funding and capital stack, target investors and their objectives.

We partner with our clients, working alongside the stakeholders in developing and agreeing the appropriate structure up front. A simple meeting or call prior to signing a contract, a heads of agreement or drafting legal documents can make a material difference. The level of any further detailed advice required is project specific.

Q. What are the main barriers that your clients are facing in getting build-to-rent projects off the ground? How can these barriers be overcome?

A. Clearly many feasibilities across all real estate projects have struggled in many States over the last few years, due in part to high construction costs combined with high interest rates. Investor capital into the build-to-rent sector has also been subdued due to a combination of factors, including its infancy in Australia, the need for ‘patient capital’ and a market where double-digit returns from first mortgage debt funds is possible.

Further, the funding equation for build-to-rent projects are fundamentally different to build-to-sell (BTS) projects. In a build-to-sell project, pre-sales can significantly derisk projects and the lifespan of a project from financial close to completed product and sales provides clear return profiles within an attractive timeframe. With build-to-rent, capital requirements require sizable funds that needs to be patient and invested for the long term. This type of investor is typically institutional, who naturally have greater due diligence demands to ensure any project risks are clearly worked through and managed.

The affordable housing targets within large build-to-rent projects to secure planning approval or fast track planning processes can also materially impact feasibilities. The recently enacted income tax concessions for eligible build-to-rent developments also require at least 10% affordable dwellings. While not fatal to a project, and clearly there is a strong need to support affordable housing solutions, the impact of these obligations to a project design needs to be carefully worked through.

Some of these challenges are cyclical as it appears that construction costs and labour shortages are starting to stabilise. In addition, as interest rates start to drop, the attractiveness of property development returns begin to exceed the relative risks.

But ultimately, to counteract the negative impact to returns on holding large build-to-rent assets long term and to encourage investment, there needs to be government support of the sector.

Q. What is the importance of international investment in the build-to-rent space?

A. The build-to-rent market in US and most European markets (known as Multifamily) is considerably more mature, so offshore institutional capital understands it, its return profile and growth opportunities.

We have seen through our clients that offshore investors show an increasing interest in the Australian build-to-rent sector and other living sectors (including student housing and retirement living) with predictable and stable income producing returns. This is combined with increasing demand for rental accommodation as attitudes to renting in Australia shift and the relative cost-to-income of the property market persuades consumers to rent rather than buy.

Australia has also been seen as a relative safe haven having weathered several global financial movements and crises. It draws investment as a stable economy with a strong regulatory structure and a growth underpinned by resources and an international migration program.

For these reasons, it has been international investment that has driven a large portion of the initial growth in the build-to-rent sector. Without this investment, many projects would not have commenced, particularly as some foreign investors are comfortable taking on the development risk rather than limiting investment to stabilised assets.

However, we have a tax and duty system that has historically not supported (and in some cases punishes) foreign investment into Australian property through additional duty, land tax surcharges, non-concessional withholding taxes, and potential denials of income tax deductions. Therefore, tax incentives in this space are important.

As the sector matures, we would hope to see greater participation from domestic institutional investors, including Australian superfunds. It would appear that there are certainly some signs of this starting to occur but this is likely to increase as more stabilised (post-completion) assets are on the market.

Q. Are you seeing an increased confidence from your client base in the build-to-rent space following the implementation of the new tax incentives? If so, why?

A. The recent passing of legislation in respect of tax concessions for eligible build-to-rent developments is welcome news. These provisions were first announced in May 2023, but the legislation only just received royal assent in December 2024 and there has been uncertainty as to how some of the criteria would be enacted.

The legislation broadly provides for the following:

An increased capital works deduction rate from 2.5% to 4% where construction commenced on or after 9 May 2023;
Reduced final withholding tax rate on eligible fund payments from eligible build-to-rent projects within managed investment trust investments from 30% to 15% for payments made on or after 1 July 2024; and
Introduces a potential claw back mechanism via a so-called ‘misuse tax’ where the eligible build-to-rent project no longer qualifies within 15 years.

In addition to the above income tax concessions, various States have implemented land tax and duty concessions to reduce the impact these taxes have on overall returns. Some of these concessions (implemented in Victoria, New South Wales, Queensland, Western Australia and South Australia) include the following:

50% reduction in the land value for the purposes of calculating land tax (reducing land tax liability); and
exemption (or refund) for foreign purchaser duty and foreign land tax surcharges.

The criteria on what is “eligible” build-to-rent developments is slightly different for each State and also slightly different to access the income tax concessions.

We continue to see interest in these incentives and concessions from across our clients, investors and developers. Further, any new project that includes a build-to-rent element have been seeking to incorporate these where possible into their structures, modelling and feasibilities.

The reduction to land tax, withholding tax and enhanced depreciation deductions provide a material uplift on after tax returns particularly for foreign investors when compared to build-to-hold assets in commercial and industrial categories. This can go some way to bridging the shortfall in yields.

However, some concerns around onerous eligibility criteria have tempered the enthusiasm.

There is a 15 year compliance period with a build-to-rent misuse tax applying where a project ceases to be eligible during this period. This may occur for example where the property ceases to be held by a single owner, reporting obligations are not met, or the affordable housing requirement does not continue to be satisfied.

The affordable housing requirement requires 10% of the build-to-rent development to be dwellings rented at 74.9% or less of the market rent for comparable dwellings. While clearly some affordable housing component is necessary, the impact of this revenue reduction at the top-line can potentially more than half the overall benefit of the withholding tax concession. Furthermore, the legislation references other prescribed conditions to be released by regulations that may place further restrictions on the segment of tenants that may lease these dwellings, potentially further reducing rental revenue.

As always, getting the structure right from the start to be able to access the incentives and concessions will have a material impact.

Notwithstanding the challenges, for build-to-rent projects that otherwise stack up, the tax and duty incentives can be significant and play a strong role in growing the sector. As the current macroeconomic environment improves, and the sector grows, we hope to see more domestic investor appetite and additional incentives supporting Australian investors to grow the number of projects and assist in alleviating the housing shortfall.

Q. Looking ahead, what additional tax incentives would encourage development to increase housing stock in Australia?

A. From a tax perspective, there are other areas where incentives or relief should be investigated.

Of particular importance is the GST cost, where the GST impact of a build-to-rent development is a fundamentally different equation to that of build-to-sell projects. The supply of accommodation in build-to-rent premises will generally be treated as an input taxed supply of accommodation in residential premises. This results in an inability to claim input tax credits in respect of land acquisition, development costs and associated operating / management costs. This in turn creates material GST leakage to a project.

The same leakage does not apply for commercial residential such as student accommodation or hotels. We would therefore like to see a broadening of the GST concessions that is currently available for Commercial Residential to apply for eligible build-to-rent projects.

The existing tax and duty incentives can also go further. While the reduced withholding tax rates and exemptions from foreign surcharges on duty and land tax are important, these are only of benefit for foreign investors. Given where the current investor appetite in this sector lies, these incentives are vital but we would hope that additional cuts directed at benefiting Australian investors are introduced in future.

In considering the recent incentives and any future incentives introduced, I also highlight the role that affordable housing criteria has to play. While an affordable housing component was always going to be required in accessing the build-to-rent income tax concessions, the build-to-rent segment should not be overburdened with meeting these targets in isolation.

By placing the load and obligation on this segment, the Government risks stifling projects from getting off the ground. A more broader solution applicable across all residential development should be considered through incentivising investment. One such approach that has been highly successful in other jurisdictions, including the United States, is providing tax credits for affordable housing. This encourages developers to build more affordable housing units, with tax credits that can be utilised by the project or allocated to investors. These credits could be allocated based on the number of affordable dwellings created and maintained.

The future of build-to-rent in Australia is strong and the evidence from similar markets offshore demonstrates the importance this sector will have on our economy and people in the years ahead. While it is sensible to get regulation and incentives right, Federal and State Government support in a timely manner is vital to continue this growth.

The information provided in this article is for general informational and conversational purposes only. While we strive to ensure the accuracy and relevance of all content, we make no guarantees about the completeness, reliability, or suitability of the information for any particular purpose. The views and opinions expressed in this article or associated materials are those of the respective contributors and do not necessarily reflect the views of Harwood Andrews or any of its affiliates.

This article is the fifth in a series of Housing Insights. Follow us to be notified when the next instalments are released.

1st instalment: HA Housing Insights: A Policy Perspective - Q&A with Mike Myers, QLD Chair of Housing All Australians
2nd instalment: HA Housing Insights: Housing market overview with - Q&A with Jesse Radisich, JLL
3rd instalment: HA Housing Insights: A builder perspective on the housing crisis - Q&A with Jess Jones, Balmain & Co
4th instalment: HA Housing Insights: A lender’s perspective on the housing crisis - Q&A with Bruce Wan, MaxCap Group

Continue reading:
6th instalment: HA Housing Insights: A developer’s perspective on housing solutions - Q&A with Tim Copley, McNab

For more information or to be featured in our HA Housing Insights series please contact: