Project Finance for Social and Affordable Housing

SMBC discusses the challenges, opportunities and support in place to enable safe and affordable housing, which is central to the security and dignity of every person.

Safe and affordable housing is central to the security and dignity of every person. While access to shelter is a basic human right, Australia, like many other nations, is experiencing significant housing challenges.

Governments around Australia are implementing a variety of programmes to address these challenges, prioritising those most in need. Delivery models vary between jurisdictions and a new set of innovative solutions are now being tested and implemented. This article explores the role that private sector project finance can play in the sector.

The housing crisis

It is widely acknowledged that Australia is in the midst of a housing crisis. The Federal Government’s National Housing Supply & Affordability Council (the council) recently published its first annual report analysing the state of the national housing system.¹ As the council concludes, the primary problem is the nation’s longstanding failure to deliver sufficient housing of all types.

The current supply of new housing is very low. Approximately 173,000 dwellings were completed in each of 2022 and 2023, the lowest annual completions in the past decade. Home construction is taking longer, with the average time from approval to completion of a new house now taking about 12 months, up from nine months in 2019–20.

Increasing construction costs, driven by materials cost inflation and labour shortages, have eroded developer and builder profit margins and limited the extent to which higher prices induce new supply. These higher costs, overlaid on historically priced contracts, have resulted in significant financial losses, eroding capital for many developers and builders and contributed to higher-than-average insolvency rates, reducing capacity and risk appetite. Higher interest rates have increased the cost of debt for builders and developers, as well as the cost of financing for households and investors. These cyclical factors are compounding longer-term structural barriers.

Construction industry productivity has fallen by 0.2% pa since 1989–90, while productivity in comparable industries has increased, including transport, 0.9% pa, and manufacturing, 0.3% pa. Land for housing is limited and costly, and complex zoning and planning approvals further constrain supply.¹

While at its heart, this is about insufficient supply, more recently demand-side factors are exacerbating the problem. These include migration resumption following the Covid-19 pause and higher interest rates and rents combining to create an environment in which prices and rents are growing significantly faster than wages, and rental vacancies are near all-time lows.

TABLE 1: NET NEW DWELLING COMPLETIONS

Source: National Housing Supply & Affordability Council

Population growth was 634,500 in the year to June 2023 and is forecast to be 510,400 in the year to June 2024, well above the average of around 376,000 over the five years preceding the pandemic. The Council estimates 244,000 households, ie new families or groups dwelling under the same roof, were formed in the 2022/23 financial year and 208,000 are expected to be formed in this financial year.

Social and affordable shortfall

Lack of a secure home is a source of significant stress for families and individuals, with 169,000 households on public housing waiting lists, and 122,000 people experiencing homelessness. Projected housing supply for this cohort is very low.

Investment in social housing contributes to the overall supply of new housing. However, social housing has been declining as a share of the housing stock for three decades, from 5.6% in 1991 to 3.8% in 2021. The Council notes that this reflects the low rates of investment and the sale and demolition of existing public housing units, only partly offset by growth in community housing.

Demand for social housing continues to outpace supply. Waitlists for public housing increased by 9.1% from 2019 to 2023, while waitlists for state-owned and managed indigenous housing increased by almost 10% from 2021–22 to 2022–23.

Beyond social housing tenants, affordable workplace proximate housing is also required of the nation’s essential workers, such as nurses, teachers, childcare and aged care workers and police officers. Anglicare estimates that nurses can afford just 1.5% of rental homes, and aged care workers and early childhood educators’ affordability are measured at only 1.1% and 0.9%, respectively.²

According to work done by Aware Super, Australia’s third largest pension fund, failure to provide affordable housing to this cohort is costing the nation A$64bn.³ Aware is a pioneer in the Australian build-to-rent sector and has already committed A$1.5bn over five years to fuel the development of more than 2,000 apartments including affordable housing.

A range of solutions

Governments around Australia have responded to the crisis in the social and affordable housing sector with significant funding and programmes to address the supply shortfall. Commonwealth-funded policy measures are targeted to add an additional 40,000 social and affordable dwellings over five years and state and territory programmes account for tens of thousands more. Major programmes around Australia, include:

Housing Australia Future Fund, Federal - The Federal Government has committed A$10bn to the Housing Australia Future Fund. The HAFF was established in 2023 as a dedicated investment vehicle to provide funding to support and increase social and affordable housing, as well as other acute housing needs including indigenous people, women, children and veterans.

The HAFF aims to support the delivery of 20,000 new social and 20,000 new affordable homes across Australia over five years by creating a secure, ongoing pipeline of funding to registered Community Housing Providers (CHPs) and their partners, including developers, investors and financiers.
Eligible projects can include the construction or purchase of new homes, the renovation of existing dwellings that were otherwise uninhabitable, or the conversion of non-residential properties to residential dwellings. Projects must reach the operational stage by no later than five years after contracting. HAFF funding products include 25-year availability payments, concessional loans and in exceptional circumstances, upfront capital grants.
Ground Lease Model, Victoria - As part of its Big Housing Build policy, the Victorian Government has successfully developed and rolled out two iterations of the Ground Lease Model programme (GLM), with more projects expected. Under GLM, Homes Victoria leases land to a private sector consortium to build, operate and maintain housing on the site for 40 years, before it is returned to public ownership at the end of the concession. As part of an integrated housing model, there will be a mix of social, affordable, specialist disability and market rental homes across the sites to provide greater diversity in Victoria’s rental stock.
Housing Investment Fund and GLM Pilot, Queensland - Queensland’s Housing Investment Fund (HIF) is a similar developer-led model to the Federal HAFF. Funding is offered by way of availability-based dwelling subsidy payments and/or capital grants. The programme is aimed at encouraging private sector developers, builders, CHPs, and investors to form partnerships to develop, finance and operate 5,600 additional social and affordable home commencements.

Queensland is also exploring its own version of the GLM, in order to partner with the private sector and demonstrate what can be done on state-owned land. Queensland’s GLM will be piloted at locations being explored in Varsity Lakes, Mango Hill and Pimlico.

Other states and territories – Numerous other social and affordable housing programmes, comprising a variety of delivery models of varying sizes and stages of progress, exist across other Australian states and territories. These include Western Australia’s and New South Wales’ mixed use redevelopment projects, including Pier Street and Waterloo Estate, respectively.

The scope, breadth, and diversity of programmes across Australia demonstrates the significance of the crisis and the preparedness and commitment from State and Federal tiers of government to redress the problem.

Precedent project finance deals

The Federal Government’s HAFF is not only of size and scale to provide a meaningful impact on social and affordable housing supply, it is also attracting significant interest from providers of private capital (both debt and equity) and the commentariat. The first round of applications attracted bids from 37 CHPs totalling 22,600 homes, worth A$13.8bn, well exceeding the nominal first round cap of 8,000 homes.

While the HAFF may be most prominent in public discourse, there are limited recent local precedents for privately financed projects in the sector. Australia remains behind markets such as the United Kingdom and the nation is still maturing models that can be delivered at scale with investment and finance from the private sector.

GLM2 case study – Most recently Victoria has successfully closed its first two GLM projects, with consortia led by sponsors, Tetris Capital and Abrdn and financed by private sector lenders, Sumitomo Mitsui Banking Corporation (SMBC) and ANZ, as well as Federal Government policy lender Housing Australia.

In November 2023, SMBC acted as joint sustainability coordinator for a new A$221.6m five-year sustainable term capex facility for the Tetris and Abrdn led consortium to deliver GLM2. GLM2 will replace existing aging residences with safe, modern and energy-efficient homes, as part of Victoria’s plan to respond to the critical undersupply of social and affordable homes across the state.

Construction of the 1,400 homes will take approximately three years, with sites ready to be inhabited from late 2026 onwards. The transaction is uniquely structured as a hybrid PPP-model, with a state service payment, supplemented by rental revenue streams. Most of the new dwellings are social, affordable and specialist disability residences, with the remainder being market rental apartments.

Speaking about GLM2, Abrdn’s head of infrastructure funds, Bill Haughey, said: “Abrdn has been investing into the social housing space for over two decades, facilitating the build or refurbishment of over 10,000 social and affordable properties through PPP and similar models. Whilst housing may not be as technically complex to construct as light rail systems or energy from waste facilities, it remains important to ensure we have construction and operating partners with the appropriate credit quality and expertise to deliver defect-free housing which is robust and managed to a high quality, to stand the test of time in a social and affordable environment.

“ESG is an important consideration when investing and housing is no exception – we consider providing new homes with a green star 5-star rating and an aspirational average NatHERs rating of 6 or higher is desired. We want to ensure tenants not only have a nice home in which to live but one which is affordable from a heating and cooling perspective.”

When considering lending decisions, banks such as SMBC take comfort from the experience of sponsors such as Abrdn and Tetris. SMBC agrees with Abrdn’s focus on the credit quality of consortium construction partners. Both GLM1 and 2 are being built by D&C contractor, Icon Construction.

Rhys Gilhome, new business manager for Icon Construction in Victoria, said: “Australia is grappling with a persistent gap between housing supply and demand, accentuated by rapid urbanisation and population growth. This imbalance underscores the urgent need for innovative solutions to tackle the affordability crisis, particularly in urban hubs like Melbourne.

“Within this context, PPP finance emerges as a potent tool for leveraging private capital to address public infrastructure needs, including social housing. The GLM projects exemplify successful PPP ventures, where private sector expertise and capital are harnessed to deliver essential housing infrastructure.

“The GLMs involve various housing types, including low to mid-rise construction, catering to various income levels within the community. By leveraging ground lease arrangements and combining public and private resources, the GLMs aim to provide sustainable and inclusive housing options, addressing the pressing need for affordable accommodation in Australia’s urban centres,” said Gilhome.

“The projects offer a sustainable financing mechanism for social housing development, thereby alleviating financial burdens on governments and enhancing project viability. Notably, GLM2 with the involvement of SMBC, signifies the convergence of private sector capital and institutional expertise in driving housing PPPs initiatives forward.

“In social housing PPPs, where private sector involvement is crucial, the financial strength of construction companies plays a pivotal role. A robust balance sheet signifies the ability to navigate market uncertainties, meet financial obligations, and instill confidence among stakeholders. Construction companies with strong financial credentials, such as Icon, are better positioned to undertake social housing PPP projects effectively. They can better support project risks, manage costs efficiently, and attract favourable financing terms from lenders and investors,” he said.

Risk allocation

With only a small number of local market precedents, the most effective procurement models and related project risk allocation remains an open question. Developer-led delivery models require private sector proponents to bring housing sites and typically bear the post subsidy period value-risk. This is compared with state-owned site-renewal projects, such as GLM, which are concession-tenor limited and projects are returned to the state at concession end.

Mixed use projects require proponents to evaluate market rental risk, as well as social and affordable rents and then factor in the possible interaction of the two. Contractors in the housing construction market are often of a smaller scale, with correspondingly smaller balance sheets. As noted by Abrdn and Icon, this is an important consideration for both debt and equity. Private sector capital providers must balance these risks and the associated returns.

Project scale is another consideration for the private sector. The GLM deals each aggregate site renewal works across four separate locations, creating an overall project of scale to justify the substantial time and fixed cost required in the bidding and investment processes. Different procurement models may call for similar, or even broader site aggregation, or conversely may entail singular large developments of a size to warrant individual site-specific financing.

The Federal Government has publicly courted the nation’s pension fund sector in relation to the HAFF. Big fund managers look for opportunities corresponding to their own scale and in order to attract investment from these players, the sector will need to find innovative ways to meet this requirement.

For heavily regulated lenders, such as banks, the choice of the appropriate credit-lens to view the sector is also an important question. First, which is the most appropriate team within a bank to assess sector risks and structure the deal? Second, Infrastructure Project Finance and Real Estate Finance may both support “real assets”, but they are not always happy bedfellows.

Regulatory rules governing bank risk-capital requirements can vary based on financing structure, impacting return outcomes. Accordingly, credit structuring and even terminology used within a financing may impact bank appetite. For example, something as esoteric as how documents label (or a financial model calculates) post-subsidy period cashflows, may drive a different risk-grading methodology within a bank, impacting pricing that can be offered, or even ultimately lending appetite.

In precedent deals in the United Kingdom, operating risk such as vacancy has traditionally been allocated to CHPs. UK CHP’s have developed the requisite capabilities of this role and in many cases also sustain large and robust balance sheets. In Australia the existing CHP sector is already of reasonable scale. However, many CHPs are still building relationships and capabilities to work with the private sector and risk allocation for emerging delivery models may also be an open question.

A hopeful future

The good news is that the social and affordable housing sector appears to be making up for lost time. Alongside the significant funding commitments from state and Federal governments, there is enormous goodwill to innovate and overcome challenges. As shown by the success of the GLM transactions and the immense interest in the HAFF, private sector participants are coming to the party and are keen to play their part.

In recent years, private capital has significantly embraced socially responsible and social impact investing and lending – according to Private Equity International, almost US$80bn of impact investment funds were raised globally in the three-year period 2021–23.⁴

SMBC’s Group Management Plan identifies Social Value creation as a key pillar and aims to set and disclose impact based KPIs, which measure the group’s impact on society. In this vein, SMBC is eagerly exploring ways to back our clients in the social and affordable housing sector in Australia, including via the HAFF, and is already supporting the sector with lending commitments, such as GLM2.

SMBC has undertaken a deep dive into its contractor client base and is engaging widely to collaborate with those interested in the social and affordable housing sector. Investors and other banks are equally keen – the private sector is stepping up to play its part!

Footnotes & References

1 - State of the Housing System report (2024), National Housing Supply & Affordability Council
2 - Anglicare Australia’s Rental Affordability Snapshot (2022), Anglicare Australia
3 - Essential worker housing affordability crisis costing A$64bn (2023), Aware Super
4 - Why impact’s long term fundraising outlook remains bright (2023), Private Equity International

Co-authored by Jan Gabrynowicz, Head of New Energy & Resources, Infrastructure, Energy and Resources Australia, Brett Ruitenberg, Managing Director and Head of Infrastructure, Energy and Resources Australia, and Tarek El-Rakshy, Managing Director and Head of Structured Finance Australia from SMBC Structured Finance Department Asia Pacific. This article was first published on PFI Global Infrastructure Report in July 2024 | pfie.com. Image credit to PFI.