NRAS Story.

On the face of it, the National Rental Affordability Scheme (NRAS) seems like an excellent option for managers of their own superannuation funds. And if approached carefully, it can be. But it is a government initiative that has had many teething problems and while most of these difficulties have been overcome, dangers remain. There are also growing concerns that there will not be enough investments offered in the future. In some states there are few or no NRAS dwellings available. NRAS was a policy created by the Howard Coalition government which was designed to encourage private investment in affordable housing. This was to be achieved by having intermediaries, either developers or approved consortiums, arranging for the building of dwellings that are rented out with discounts of at least 20 per cent and sometimes up to 30 per cent. To compensate for the lower rental income investors receive a tax free annual payment from both the Federal government and the State or Territory government. This payment is indexed to inflation and is currently $9,981 per annum. It applies for 10 years, at which point the scheme ceases and the dwelling reverts to being a normal property investment. Brendan OConnor, the Federal Minister for Home Affairs says NRAS is a $4.5 billion scheme that constitutes one part of the governments $20 billion investment in more affordable housing. He says eleven thousand homes have so far been sold and 40,000 more homes are supposed to be sold by 2016. This scheme is intended to be attractive for participants, while helping to increase the supply of affordable housing, saving low and middle income tenants thousands of dollars each year, says OConnor. The incentive paid is designed to compensate the investor for the discounted rent, and to provide an incentive for the construction of the new rental home. The financials can be compelling, especially if the property is comparatively cheap. The government payment is a tax free flat fee, irrespective of the price of the dwelling. So the cheaper the property the more attractive the yield on the investment becomes. To illustrate, take the example of two bedroom units and townhouses, priced at $330,000, which are currently being advertised in Melbourne and which have qualified for NRAS. The average market rent for the area is $330 per week. After applying the NRAS discount, the property will be rented out at $264 a week. The NRAS payment from government to the investor is the equivalent of $192 a week, leaving a total weekly return of $456 a week. This equates with $23,712 a year, providing a gross annual return of 7.2 per cent. The net return, after subtracting costs such as the payment to the property managers (typically 810 per cent of the rent), strata title payments and rates, should be more than 6 per cent, a higher return than the average property investment. It compares favourably with the returns on cash and dividends. Assuming there is a steady increase in the capital value, the total return over 10 years could easily be in the double figures. Investors can leave the NRAS at any time without any financial penalty, at which point it becomes like any other property investment. The only fee that is different between an NRAS and a non-NRAS property is the NRAS compliance or administration fee, says Jo Brown, managing director of NRAS Real Estate. Most of the management fees that we deal with are 10% of the rent collected which is the same as a normal market property anyway. You have a normal manager like with any other property but you also have a manager of the scheme that is a different fee to any other investment property. Jonathan Cattana, director of Habitus Asset Management, says for super fund investors a minimum investment is typically between $100-120,000. It depends on the contributions,

but if there are good contributions and not too many issues, and assuming they are employed, then that amount should suffice. Then, with borrowing it leverages them up to that $300,000 mark. Cattana advises that it is important to pick the right consortium and properties in the right regional growth areas. Investors should not have loan to valuation ratios of higher than 70 per cent. Then we find a developer who is self managed super fund friendly (SMSF) too, because you have got to be careful about all the borrowing laws when you have a self managed fund. Once the client is set up, we say we think this area will go well, it might be Toowoomba at $285,000, 2 bedroom unit or it might be Townsville at high $280,000s, one bedders. Gross yields for properties in that range, he says, can be 8-9 per cent. Bill Nikolouzakis, managing director of agency Urban Seed Project Marketing says the scheme works well with superannuation because of the cash flow that comes from the combination of the government payment and the rent. He assesses it this way. The government payment adds up to between $100,000 and $118,000 over the 10 year period. It costs about $3,000 to $4,000 in lower rent but (investors) gain $10,000 each year in a tax credit so effectively they are $5,000 to $6,000 ahead of the game. These are some of the positives of NRAS, but there have been negatives. Cattania says in the early days the scheme was butchered with developers and consortiums charging huge fees and putting on overpriced products. Even in Victoria you were getting consortiums charging $10-15K for an NRAS incentive. All those bugs and typical things that go on in the property industry have been removed and ironed out. Nikolouzakis agrees that the scheme in the early days was not well managed. We never got involved in the first three years of the scheme because it just wasnt a good product, he says. What used to happen is that developers used to have to go to the government directly. It was not a good process because the only people who were doing it were people who were desperate for sales. That has all changed now. Now the actual agreement that tells you that you have NRAS on that property is called a non-entity joint venture agreement. All the major banks lend against it up to 80 per cent. It has made it a much better product over the last year and a half. Whether these improvements can be sustained remains to be seen. There are growing questions about the commitment of the Federal government to the scheme. Rob Caruso, property guru for the West Australian based NRAS Property Solutions says he expects very few NRAS properties will be offered in his state. In 2008, he says, when the scheme began, there were supposed to be 100,000 properties built. If half of that number were delivered by 2012, then the second 50,000 would be allocated. The hitch was that Julia Gillard got in power and Queensland had a flood, says Caruso. So the money for the other 50,000 dwellings (the second half of the allocation) was taken out of the account and those 50,000 proposed dwellings were scrapped. The money was used for flood relief. To make matters worse, Caruso says the release of funds to pay for 15,000 dwellings of the initial allocation of 50,000 has been postponed until 2015. They are what a lot of people are talking about as round five allocations. But they have already been applied for and they have already been given out to the developers. The hitch is they (the developers) cant deliver until the middle of 2015 because that is when the money will be available from the government, the payment of $10,000 a year to investors. Caruso says many developers, faced with the extra delays, have gone ahead and built without the NRAS benefit. A lot of developers, who buy a piece of land for $4 million cant

sit on it until the middle of 2015. The choice of the managers of the property is an important investment consideration. Caruso says many consortiums, to make their applications stronger, enlisted not for profit organizations as their property managers. It gave them extra weighting to get their allocations through. Some had head leases almost identical to the Defence Housing model. Banks would not lend against such property. Those head leases involved having a caveat on the property and basically handing it back to the government in 10 years and having no say. It was difficult to on sell there were a whole heap of issues. Then a couple of consortiums got tax rulings and found ways to do it without a head lease. According to a study by Sydney-based Money Tree Partners, some NRAS operators still utilise the head-lease structure. It says these are to be avoided. In effect, this means that you are leasing your property for 10 years to the NRAS operator and in turn they sub-lease it to an eligible tenant. In such cases you will have limited or no control over the selection of either the managing agent (generally head-lease operators are the managing agent) and little or no control over the selection or approval of the tenant. In fact, you will generally not be a party to the tenancy agreement so will have limited legal standing at the tenancy agreement level. Caruso warns that when the property manager is from a not for profit organization they will often give a 25 per cent discount to renters and the investor will have little say over who are the tenants. The question I would ask is who is the property manager? Is it not for profit or private? If it is private you have pretty much ticked all the boxes. If it is not for profit and the stock (dwelling) is outstanding then may be worth buying the property. You can take on the risk. The Money Tree study also warns that investors should carefully examine the termination provisions if the investor wants to exit the scheme. Many NRAS operators have restrictive termination provisions, particularly under head-lease structures. Assuming that the property meets these requirements, the investment returns can be sound. NRAS Real Estates Jo Brown considers the most important consideration to be the price. She says otherwise the NRAS should be treated like any other property investment. I think the only down side is do your due diligence on the price. There are often far too many commissions in them which have pushed them above what they are really worth.