Investor Alert: Is This The End Of NRAS?
In This Article
- Synopsis
- Introduction
- What Is NRAS?
- What Impact Does NRAS Have?
- What’s Good (In Principle) About NRAS?
- What’s Bad (In Principle) About NRAS?
- What’s Dangerous About NRAS?
- The Budget Impact
- Recommended Action
Synopsis
The decision to no longer proceed with the fifth round of NRAS funding will have an immediate and profound impact on developers selling into this niche. Furthermore, there may be a negative knock-on effect to investors who have committed to buy an off the plan property and those seeking to sell a second-hand apartment. All those who own a NRAS property are encouraged to reassess their property portfolios. Furthermore, all investors should be aware of the new market dynamic.
Introduction
In an effort to find ways to cut spending, the Federal Treasurer has announced the fifth round of NRAS funding will not be going ahead, and that any unused NRAS allocations from previous rounds would be cancelled.
Before you yawn and think ‘so what’, this seemingly trivial change is expected to have a big impact on certain developers and investors.
Let’s take a moment to review what NRAS is before considering how the change may impact property investors.
What Is NRAS?
Back in 2008, then Prime Minister Kevin Rudd introduced a scheme he hoped would prop up the construction industry (that was reeling in the midst of the GFC) and, at the same time, increase the supply of affordable housing.
The scheme was called NRAS – an acronym that stood for the National Rental Affordability Scheme. Here’s a quick summary of how it works.
- Developers could register eligible dwellings and gain NRAS approved housing status as a marketing edge
- Investors buying NRAS approved dwellings (from developers) and who rented them to eligible tenants at 20% or more below market rent were able to access an annual tax free incentive
- Currently the NRAS incentive is about $10,000 per annum, is tax-free and indexed to CPI.
- Access to the incentive is up to a maximum of 10 years
- If the property is sold before the ten year period expires, the new owner can access the NRAS incentive provided the NRAS obligations are honoured.
What Impact Does NRAS Have?
Properties sold ‘off the plan’ (prior to completion) are usually negatively geared before tax incentives, and possibly neutrally or positively geared after so-called tax savings (arising from the excess property expenses over rental income being used to offset other taxable income).
What NRAS has done is increased the tax effectiveness of the investment, thereby greatly increasing the prospect that an otherwise negatively geared property will, after NRAS adjustments, be positively geared.
What’s Good (In Principle) About NRAS?
NRAS has helped:
- Developers gain a marketing edge to facilitate higher sales, leading to an incentive to increase housing supply, with positive flow on effects to the construction industry.
- Investors are rewarded for supplying and maintaining affordable housing via a tax free incentive.
- Eligible tenants who needed assistance in the form of good quality housing at below market rents.
What’s Bad (In Principle) About NRAS?
It hasn’t taken long for clever Aussie investors to find a way to apply NRAS in ways not previously envisaged.
For instance, student housing is a surprise benefactor of NRAS incentives as the NRAS incentive is not tied to the property or its value, but rather the same amount is offered for every property regardless of location, number of bedrooms, etc.
Clearly a $10,000 NRAS incentive has more impact on a $150,000 (tiny) student apartment compared to a $300,000 (spacious) two bedroom unit that is more suitable for a single parent or couple.
Furthermore, while the financial benefits of the incentive may sound attractive, NRAS eligible tenants must still be found, and with a lot of new supply and a limited tenant pool, vacancies (i.e. periods of no rental) of several months have been reported both in finding initial and replacement NRAS eligible tenants.
It should also be remembered that, like rental guarantees, the NRAS incentive is in some way built in to the purchase price to compensate developers for the extra compliance needed for their stock to qualify for the scheme.
Finally, the value of the NRAS incentive to another owner diminishes as the number of eligible years remaining declines. For example, everything else being equal, a property with 5 years of NRAS incentives remaining would be less attractive than one with 6 years remaining.
What’s Dangerous About NRAS?
The biggest danger about NRAS is not at the time of purchase, but rather at the time of sale.
Any housing market where investors own a disproportionate number of dwellings in the location or development brings with it a high inherent risk that supply spikes will lead to a swift price correction. The effect is made even worse if forced sales eventuate.
Reflect for a moment on the recent price correction in a number of mining towns. Attracted by massive rents, home values in locations such as Mackay, Blackwater and Moranbah rose quickly as investors snapped up the high yielding properties.
Times were good, until redundancies and fly-in-fly-out arrangements meant fewer tenants and led to rents dropping by as much as 50%.
Investors unable to afford the interest and holding costs on no or low rent looked to exit, yet with so many properties now for sale and quite a number of motivated sellers, the few buyers who weren’t scared off could negotiate incredible terms with vendors forced to compete with drastic price reductions.
Applying this logic to NRAS, let’s say there is a 20 unit development which qualifies for the NRAS scheme and has been on-sold to investors. For simplicity, let’s say the same investors hold the property for 10 years.
Fast forward to Year 11 when the NRAS incentive ends, and at which point five investors seek to exit (sell) as they cannot afford the after-tax negative cash flow.
With five units (25% of the development) up for sale at once, it is reasonable to expect that a savvy buyer would look to negotiate the best possible deal by ‘reverse Dutch actioning’ one seller against the other. In this situation, the seller offering the lowest price would be the winner, meaning the capital appreciation earned over the preceding ten years could be quickly eroded, for all owners.
Speaking of capital appreciation, being forced to charge 20%+ below market rent must result in a lower rental return, and therefore diminished comparable attractiveness to other property for sale that is not part of the NRAS.
For instance, let’s say there are two identical properties – one in NRAS, the other not. The market rent on the non-NRAS property is $400 per week. The reduced rent charged on NRAS is $320 per week. Assuming the market return in that area is 7%, the $80 per week discount equates to decease in value of up to $59,428!
(Just on this point… as an investor, everything being equal, which property would you be more likely to buy? The one renting for $400 per week, or the one renting for $320 per week? Clearly the $400 per week property! How much would you discount the lower renting property by? The sum of the lower annual rent divided by the market yield.)
The Budget Impact
Deciding to end the NRAS incentive early will have a negative impact on:
What / Who? | Why? |
Marketing firms that operate in the NRAS niche | No more sales commissions |
Firms that assist with compliance and monitoring of NRAS commitments | No client growth |
Firms that assist with compliance and monitoring of NRAS commitments | Declining revenue as NRAS incentives expire and as owners exit from the scheme |
NRAS Investors | Higher compliance costs is NRAS compliance firms increase their charges to preserve profit margins |
Developers | They lose an avenue to promote stock and have to find other avenues to sell |
Non NRAS investors who have bought off the plan and are waiting for their properties to be built | Because stock that may have been allocated for NRAS sale will need to be reassigned, the extra supply may cause developers to cut their margins putting downwards pressure on values |
Non NRAS investors who have bought off the plan and are waiting for their properties to be built | A possible knock-on effect of the above could be lower valuations on pre-sold stock requiring investors to make larger downpayments in order to settle |
Sellers of second hand apartments | Possible price decline if developers reduce their profit margins and sell at reduced prices to liquidate excess stock |
A possible positive impact of the NRAS funding coming to an end is that it caps the number (supply) of properties that are eligible for the NRAS incentive and may in fact make those dwellings more attractive to investors seeking the additional tax-free payment, particularly those with the full ten years still available.
Recommended Action
All investors ought to be aware that although the decision to end NRAS early is unlikely to have a significant impact on the overall property market, it will certainly be felt in those sub-markets that had made NRAS their niche.
In particular, developers already committed to construction who were relying on NRAS sales will need to quickly rethink their marketing channels or else face higher business risk.
Investors who currently own NRAS property must consider how and when they hope to exit, remembering that the longer they leave it, the less value there is in the remaining NRAS incentives for the next buyer, and the more likely they will have to compete with other investors looking to exit.
Investors interested in buying new property in areas where developers have been selling NRAS property are encouraged to hold off for time being and to assess the impact of any change.
If you have a specific question about your situation then please post it as a comment below.
Comments
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Not my scence, but a great read if you’re involved or interested in NRAS property.
Thanks for the encouragement. Steve
Good informative article. I have 1 NRAS property into about its 3rd year? What do you believe will be the effects in a much longer hold strategy? I would like to think that by the end of year 10, increases of rent etc. along the way should lead to near neutral gearing anyway- so not intending to sell.
Hi,
It’s good the property has appreciated against cost, but how has it performed against market?
If the investment is working for you, then great. Just keep in mind your exit as indicated in the article.
Steve
Insightful perspective on what was a well meaning government initiative that ended up in the wrong hands in many instances.
Interesting..I have 1 NRAS property moving into its 3rd year now. It’s now positively geared after incentive payments and with an average capital growth of 3.5% pa. Has never been vacate, so NRAS is not really that bad if you pick the right area.
While it’s not a strategy I would adopt, NRAS can still be effective in situations where there is unlikely to be a supply glut.
As a rule, any investment that requires a tax incentive to be worthwhile should be very carefully and critically examined.
Steve
“In an effort to find ways to cut spending, the Federal Treasurer has announced the fifth round of NRAS funding will not be going ahead, and that any unused NRAS allocations from previous rounds would be cancelled”
Not quite correct. The 18,000 Round 4 allocations yet to be delivered have not been affected by the decision not to proceed with the 10,000 allocations planned for Round 5. The funding for the 18,000 remaining Round 4 allocations is not affected, provided the dwellings to which they have been allocated are either under contract, delivered on time or can show “substantial progress” by their delivery due date.
Given the fact the majority of the 18,000 outstanding Round 4 allocations have “use by” dates of June 2016, the opportunity to invest in an NRAS eligible property remains for another 2 years, and “off the plan” purchasers therefore have until that time in most instances ( and beyond, provided “substantial progress” can be demonstrated) , to settle.
Thanks for clarifying and contributing. Where did you get your data from?
Steve
I am a young investor and just committed to a NRAS property which is due to complete in the next few months. This article is giving me some doubts if I have make a right decision.
I am not into some knee jerk actions, but is wondering what are the options should the investment turns sour.
I recommend listing your concerns and then devising strategies to minimise risk in advance.
For instance, you should have plans in place for vacancy, management, body corp, etc.
Steve
Steve,
I’ve enjoyed all your stuff over the years mate, but we recently bought a NRAS property and the comment you make above about two properties one at $400 and the NRAS at $320. You said that it equates to a value reduction or almost $60k and that all things being equal which would I buy.. The NRAS property is recieving $192.30 each week in tax free NRAS subsidy, meaning its rent is $112.30 BETTER off than the non-NRAS property.. Being tax free and on a marginal rate of 40% thats a sweet earner of $512.30 per week.. Compared to the non-NRAS property the NRAS property is light years ahead so Im not sure why any investor would chose the lower return? Tax free money is the best there is, a small rent reduction for a larger tax free return is clearly a winner, in fact, I would argue its far too generous a subsidy and rightly has been cancelled. My experience with NRAS was positively geared from day one, but a tax free $10,000 helping balance the tax time very nicely. Love your work mate, I particularly agree with your points on an NRAS exit strategy, for us, we plan to keep it well past the NRAS end, by which time the rent returns to market and by then, will be even better than now. NRAS, is frankly, another stupid government handout thats too generous..
I agree that the biggest negative with NRAS is certain developers ripping people off in certain developments by adding 10-20k to the price. The biggest fool if a property fails could be the investor. Many investors purchased NRAS because the property possessed an NRAS license. Many investors purchased an NRAS property because it was NRAS, Ignoring the fundamentals of research and better decision making.
The underlying fundamentals of investing more successfully should have been adhered to. For example, but not limited to: trends in yield, capital growth, vacancy rates, days on market, as well as infrastructure and ‘population growth in conjunction with supply and demand’ determining decision making. If a purchaser followed the fundamentals of property investing and only then chose an NRAS property, priced the same as a non NRAS property, in the same location, they are bound to achieve the same result as someone who purchased a property with no NRAS license on it, in the same location in the same development. With the further assumption they were not stupid enough to purchase an NRAS property in a development where all the properties had NRAS licenses on them.
After 10 years, the market rent on an NRAS property would have increased, so with no NRAS remaining on it, it would probably be positively geared anyway, it would, at the very least be the same as a non NRAS property in the same development, again, if purchased properly. I do not believe therefore that after 10 years people will suddenly dump all their ex-NRAS properties on the market just because their 10 year license has ended. Based on 2 assumptions: 1. Capital growth potential remaining, external of any affect of NRAS expiring and 2. It being neutral or positively geared based on increased price and yield over the ensuing 10 years from having purchased it.
The real risk now is the increased likelihood of more developers ripping more people off as it is now potentially becoming more in demand with a very visible limited supply. I also am aware of information suggesting there are still 18,000 licenses out there.
If I were to buy a brand new property approx 15 km out of Brisbane, in a complex of just over 100 houses with approx 45 that have been allocated to NRAS but not mine. What would you suggest.
This point is interesting :
“Firms that assist with compliance and monitoring of NRAS commitments” – I’m assuming this is referring to the various Nras consortiums? I wonder if there is any government regulations as to how these consortiums operate and how much they are allowed to charge for aspects such as property management (given that nras properties typically attract a premium in this regard). Has anyone had any experiences they would like to share?