SDA: A new asset class for Australia
What is SDA?
Specialist Disability Accommodation is the 'bricks and mortar' capital element of the disability accommodation framework of the NDIS. Participants in the NDIS receive funding under their plan to go towards rental accommodation. The rental accommodation must be built to specific standards in order to meet the classification of "SDA".
The Residential Asset Class
Australia’s residential property investment landscape largely consists of two options: houses and apartments. If you want to invest in an apartment, you can buy an individual apartment under a strata (condo) scheme. Because of Australian tax policy, you'll likely make a loss on the investment and hope that when you sell in five years’ time, there's enough capital growth to offset the income losses along the way. The same goes for houses. Those losses have to be funded, so unless there is other income to cover the cash shortfall (that can grow faster than new investments can be acquired), the ability to grow the investment is restricted. This means the investor is simply hoping the asset value will keep growing, the price of that hope is the cash shortfall each year.
Put another way, investors are writing call options on the value of property and paying an option premium – if this seems nonsensical, trust your instincts.
This can work for one or two investments for an individual but does not scale well for large investment funds (see above, they lose money).
The other option is to develop apartments and either sell them (Build-to-Sell) or hold onto them (Build-to-Rent). The returns on BTR in Australia are low relative to other global markets (high cost of construction / market geared towards individual rentals).
Overseas, in places like America, the options for residential investments are greater, with many sub-asset classes in the residential space:
Built-to-Rent / Multi Family
Affordable
Low Income
Student
Rent Controlled / Rent Stabilized
Senior Housing
Behind at least 4 of these 6 sub-markets sit numerous government programs: tax abatements, PILOTS, rent subsidies, rent caps, municipal bonds, low interest loans, federal/state/local payment vouchers - the list goes on. These policies and programs are designed to maximise private capital for public good (directed to low income / affordable housing). At the end of the day, no matter what an owner charges for rent, the cost to run a building remains largely the same. By incentivising investment through lowering the cost of capital and subsidising rent, the government preserves housing for those who need it most.
The byproduct of these policy settings is a flourishing affordable housing sector, which is attractive to large institutional and smaller investors. Some of the biggest investment firms in the world have allocated capital to the space. The key is good government policy which incentivises investment.
The SDA Asset Class
Through SDA, the NDIS created an entirely new asset class was invented. This asset class is best suited to be held for the long term and managed as a going concern. The higher rent paid for certified SDA houses generates positive cash flow and the tenant base expect longer term tenancies. This is much more akin to the institutional grade residential housing seen in overseas markets and for the first time in Australia the regulatory framework has been set up to support it. Instead of lower the cost of running a property, the government has raised the income available.
SDA formally became available in 2016 and since then has worked through a number of teething issues at it transitioned from legacy housing programs to a new semi-market based system. These inefficiencies have burned many small investors due to the slow funding approval times for participants, higher compliance costs in design and misunderstandings about how the property finances really work.
Over time the systems and processes have improved, although they have a long, long, way to go. As the processes and importantly approval times become consistent and inventory of SDA grows, the market will mature into something resembling the affordable housing market in the United States. Some estimates have put the total potential of the SDA sector at $12B [$2.5b disability housing sector set to explode in size]. Taking a back of the envelope valuation approach, the total NDIS allowance for rental payments is $700m, assuming the property operates with costs of 30% then this leaves Net Operating Income of $490mt. Applying a conservative capitalisation rate of 7% this puts a value on the sector of $7B (before accounting) for any increases in rent due to CPI (the $700m figure is from some years back).
I'm certainly not the first person to highlight the potential SDA has as a new asset class, but I have seen firsthand what transpires when government policy, investment dollars and motivated fund managers join forces. It has the capacity to be huge. 20 years ago, the affordable housing sector in the United States was messy, complicated and put in the too hard basket (sound familiar?). Now, the biggest names in investment management (Nuveen, Blackstone, Starwood) play in the space. The combination of government subsidised rent, long term tenants and low volatility are too good to pass up.
Where do we go from here? SDA is the new kid on the block. As more projects are developed and a critical mass of properties come online, we will see more activity both on the investment and asset sale side.
At Capstone, we're excited about where the sector can go, and are in it for the long haul.