Much needed foreign property investment is being stifled in Australia

December 2024 | SPOTLIGHT | FINANCE & INVESTMENT

Financier Worldwide Magazine

December 2024 Issue

Australia is rightfully a destination for global capital. The relatively stable political, economic and social environment and a thirst for growth and development have produced compelling returns for investors across many asset classes.

That said, Australia is in a housing crisis. Sydney, for example, has a housing shortage of 190,000 homes in 2024, according to the Property Council of Australia, and rents have skyrocketed on average 16 percent over the past two years to 2024, according to a 2024 Super Member’s Council report authored by Saul Eslake. Add to this the high cost of living experienced by Australians, including home loan interest rates still around 6.5 to 8 percent per annum, and you have a general population that is hurting.

This has created a lot of social pressure on the Australian federal and state governments to address the housing crisis. Many have blamed a surge of immigration with annual numbers increasing by 36 percent between 2022 and 2023 alone, based on the ‘Australia’s Migration Trends 2022-23’ report by the Department of Home Affairs. Others point to policies which treat housing like a commodity to be speculated. The response to the shortage has involved low-cost debt funding and concessions for build to rent and affordable housing projects. However, the size of the housing shortage well exceeds the power of these measures.

One might think there is a solution at hand. With a number of Western countries starting to reduce interest rates (while Australia’s stay stubbornly high) foreign debt capital is cheaper than debt financing in Australia, and with Australia being a sought after destination for capital, foreign capital should be flooding into Australian housing. However, it is not.

To put it into perspective, of the funds raised across private equity (PE), venture capital (VC) and credit, typically two-thirds of capital is foreign. While there is some foreign investment in housing, it is nowhere near that level. In our view, there are two main reasons for this, as outlined below.

The first is the foreign investment rules for investing in residential property. The system is deliberately protectionist and was set up to effectively penalise foreign personal investment in residential property so as to protect supply for Australians.

Typical targets of the system were foreigners buying up large property portfolios and leaving them vacant, or deriving revenue from $50m Sydney waterfront property sales. However, the rules also capture genuine foreign investment in housing projects and build to rent projects, including the security packages that accompany debt financing arrangements.

While there is a money lending exemption for some foreign lenders (including non-bank lenders) which normally exempts ordinary course lenders from the operation of the foreign investment legislation as it applies to their security packages, it is narrower in the context of security over residential real property (being available only to authorised deposit-taking institutions or widely held entities).

Accordingly, the regime does not fit the modern alternative lending environment where funds (or other non-traditional lenders) and not banks are the lenders to these types of projects. There is no clear cut policy reason to cut non-bank lenders out of the money lending exemption when they lend money for residential real estate projects (as compared to other types of transactions).

While it is true that a non-bank lender could simply seek foreign investment approval (or even an exemption certificate) to take and enforce security over residential real estate, and in a world where the end result would be increasing the supply of Australian housing one imagines approval would ultimately be forthcoming, the sheer cost of doing so in the residential real estate context makes lenders think twice.

Fees in relation to residential property transactions have long been higher than for other applications (reflecting the policy settings behind the legislation as it applies to residential real estate). However, the Australian government has recently tripled the application fee required to invest in residential property – regardless of whether the transaction involves actually buying residential real estate or merely taking and enforcing security over it.

To show how out of proportion these fees have become, on a recent A$250m transaction to lend into residential development (where the lender would, as per normal, take security over the projects), the application fee was just under A$3m. This fee is a massive sunk cost, and investors are shaking their heads when a country is in a housing crisis and they are willing to provide the capital to help fix it. Even where a fee waiver is granted, it is typically necessary for the applicant to pay the full fee up front, and then seek a refund – this system is unworkable when the very size of the fee may mean the investor chooses not to proceed in the first place.

While the Australian government first announced in late 2023 (and reiterated in May 2024) measures to improve the fees for foreign investment into affordable housing and certain build to rent projects, which is very welcome news, the changes have not yet been implemented based on our recent experience, and the current guidance notes do not specify a timeline for implementation. We understand these changes are imminent, but even when implemented they will not extend more broadly to residential investment.

The second impediment to foreign investment in property is taxation. Unlike PE and VC, where foreign investors will often pay zero Australian tax on capital gains, investment into Australian land often involves revenue tax treatment which can mean 30 to almost 50 percent taxation leakage. The differential between asset classes has probably been founded in Australia’s love for property, whether it be the family home or our farms. Foreign investment in those sectors has always been politically sensitive.

However, with a nation facing a housing crisis and a need to maintain reasonably high immigration, Australia now needs a shift in policy and approach to foreign property investment, and it needs it fast. The social cost of the housing crisis far outweighs lost government revenues from foreign property investment.

The new approach should, in our view, involve: (i) a new test for genuine foreign institutional investors that is more aligned with modern investment and lending structures; (ii) expanding the foreign investment money lending exemption to include alternative credit funds in the context of residential real estate lending (much of the capital needed for projects is coming from the alternative credit market as opposed to the typical bank lenders); (iii) waiving (or reducing) Foreign Investment Review Board application fees for institutional investors into residential housing projects, and in particular affordable housing and build to rent projects (while the government’s announcements have sounded promising, they need to be put into action as quickly as possible, particularly in the context of taking and enforcing security); and (iv) reducing withholding tax and duties for institutional investors investing into desired projects.

It is time Australia modernised its foreign investment rules and calibrated them to the needs of the Australian public.

Deborah Johns and Nathan Cahill are partners at Gilbert + Tobin. Ms Johns can be contacted on +61 (2) 9263 4120 or by email: djohns@gtlaw.com.au. Mr Cahill can be contacted on +61 (2) 9263 4055 or by email: ncahill@gtlaw.com.au.

Deborah Johns and Nathan Cahill

Gilbert + Tobin