What's ahead for NRAS?

One of the potential casualties of the recent Federal Budget is the National Rental Affordability Scheme. Eddie Chung examines the fallout and how you can deal with it

The National Rental Affordability Scheme (NRAS) was introduced by the Rudd Government to stimulate the creation of affordable housing stock on the market. Since its introduction in 2008, the scheme has been responsible for the creation of some 14,500 dwellings across Australia.

The success of the NRAS is also indirectly reflected in  the reduction of the public housing waiting lists since the scheme was introduced. Amidst the good news, there have also been allegations of exploitation of the scheme as reported by the media; for example some of the NRAS allocations were used in student accommodation that was a suboptimal product and not an intended outcome of the scheme.

The Federal Budget dealt a fatal blow to NRAS on the night of 13 May 2014. Despite applicants having submitted their applications for the fifth round of NRAS back in August 2013, the government announced that it would not proceed with the submissions. While the government will continue to honour NRAS allocations that were made in previous rounds, any allocated funding that has not been contracted or used within the agreed timeframes will be withdrawn. Not surprisingly, funding for tenanted NRAS properties will not be disturbed.

This article looks at how the scheme operates, the potential fallout due to the latest government announcement, and how investors in these properties should respond as a result.

How does NRAS operate?
NRAS allocations are attached to specific properties, which were secured by property developers, non-profit organisations in the housing sector, and other parties interested in developing affordable housing products before the properties were built. Owners of NRAS properties must rent their properties to tenants for at least 20% less than market rent as determined by independently registered qualified valuers. 

To compensate NRAS property owners for the reduced rent, the scheme originally provided owners with a tax-free incentive from the government of $8,000 per annum over 10 years, which was partially funded by the Commonwealth Government and the relevant state government. As the incentive amount is indexed every year, the NRAS incentive is now $10,661. The tax-free status of the incentive can be highly lucrative. Some earlier NRAS properties are already cash flow positive and have been accrued capital gain in areas where demand outstrips supply.

As an NRAS allocation is attached to a specific property, rather than the owner, the sale of an NRAS property will entitle the new owner to the remaining NRAS incentives left on that property.

What are the potential outcomes of scrapping the NRAS?
Given the tax-free status of the NRAS incentives and the anticipated increase in scarcity of NRAS properties now that the scheme has been scrapped, demand for NRAS properties may potentially increase in the short term, which may drive up the prices of these properties. After all, a tax-free incentive may go a long way in making an investment affordable for some investors.

Over the medium to longer term, however, there are continuing concerns as to whether these properties will continue to grow in value. In fact, some people go so far as to question whether the prices of these properties will hold or even go backwards.

The rationale for these concerns can be found in a basic demand and supply analysis. Unless there is a severe undersupply of affordable housing stock in the future, once the NRAS incentives cease after 10 years, the properties may no longer be affordable to investors due to the following:
  1. The sudden removal of the tax-free incentives will be a direct financial hit  to the investors, who may now have to address the financial shortfall via  alternative means, eg increasing rent; and 
  2. Tenants in these properties have been relying on artificially reduced rent and may not be able to sustain their tenancies once the investors’ returns are compressed and rent on the properties is increased to compensate for diminishing investor returns. This may result in tenants pushing back on rent increases or even vacating their properties.
Either way, the ensuing financial pressure on NRAS investors may cause at least some of them to offload their properties on the market, which may in turn put downward pressure on the value of these properties for at least some time until market forces take their course and stabilise prices.

The unknown variables in this hypothesis include things that may materially affect the demand and supply equation. For instance, if Australia experiences substantial population growth or if housing supply is severely constrained for one reason or another, these factors may provide a soft landing for NRAS property prices. On the other hand, other less forgiving factors may materialise doomsday predictions that NRAS property prices will plummet.

Ultimately, while we can continue to make conjectures on what may happen based on prevailing market conditions from time to time, no one knows what the future may hold because there are simply too many ‘moving parts’ in this crystal-ball-gazing exercise.

How should NRAS investors respond?
Similar to investor behaviour when signs of the GFC began to emerge, the market is often spurred by some genuinely rational response and other wildly irrational hysteria. The difference for NRAS properties is that market reactions will probably be less abrupt as the 10-year timeframe of the scheme is a variable known well in advance.

In my view, to avoid any chaotic exit that may result in financial grief, existing  NRAS investors should project the financial future of  to determine if their investments will continue to make sense after the 10 years have expired and the incentives are no longer forthcoming, having regard to their specific circumstances.

For instance, those who invested based on affordability calculations that were close to the wire may no longer be able to afford to keep their properties once the incentives cease; therefore, they should perhaps consider selling their properties in the near future to avoid having to compete with other investors who have no choice but to sell. To that end, beware of the ‘gambler’s mindset’ – some investors may punt on short-term capital gains and hold on to their properties for too long, which may put them at risk of missing the boat when the market starts to head south.

For other investors who may still be able to afford to hold on to their properties, the question is whether their investments will continue to produce an acceptable return compared to that from other investments as an opportunity cost, bearing in mind that financial return includes both income and capital gain. While a particular NRAS property may return sufficient income even after the NRAS incentives have ceased, it will not serve the investor well if they need to realise their property as part of, say, their retirement plan at the time when NRAS property prices are on the slide.

In summary
How an existing NRAS investor should react will depend on their specific circumstances. A prospective NRAS investor should go through the same exercise of projecting the financial future of the property under consideration in light of their own situation before making a conscious choice to invest.

If the history of investment cycles continues to hold true, provided that the future income stream of NRAS properties remains competitive in comparison with other properties and investments, and the investor has ample time to hold on to their property and ride out the property cycle(s), market forces may eventually take hold and subsume the NRAS properties into the wider residential property market. At this time, NRAS properties will hopefully be in sync with other properties and generate meaningful capital growth with the rest of the market.

Eddie Chung is Partner, tax & advisory, property & construction, at BDO (QLD) Pty.
Important disclaimer: No person should rely on the contents of this article without first obtaining advice from a qualified professional person. The article is provided for general information only and the author and BDO (QLD) Pty Ltd are not engaged to render professional advice or services through this article. The author and BDO (QLD) Pty Ltd expressly disclaim all and any liability and responsibility to any person in respect of anything, and of the consequences of anything, done or omitted to be done by any such person in reliance, whether wholly or partially, upon the whole or any part of the contents of this article.


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