On a mission to rental affordability

In which I go inside the strategy Simplicity and NZ Living are using to strip out the waste in the medium density apartment 'stack' to create affordable build-to-rent apartments

I did a podcast last week for The Spinoff (it’s free to subscribe for weekly here) on Simplicity Living. I’ve written it out in more detail and transcribed an interview with Sam Stubbs and Shane Breabley for subscribers here, given the public interest involved. Subscribe to see more of my accountability and explanatory journalism on affordable housing, climate change and widening inequality.

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I’ve spent a long time covering the residential property development market in New Zealand, particularly for the type of more-complicated and desperately needed medium-density dwellings needed close the centre of our largest cities. It has bred its own culture of short-termism and zero-sum-game cynicism that inflates costs and stunts any attempts at scale and affordability.

It created the Finance company crises of 2007-11 that cost muggins savers and the taxpayer close to $5b and created the biggest hole in new home creation in New Zealand’s history, along with an exodus of skilled tradespeople to Australia, many of whom have never returned. It was a painful reporting exercise that shaped my view of whether we could ever build houses affordably in the right places for people on regular incomes.

Up until now, it’s a sector designed to take advantage (or at least live within) a pronounced boom-bust cycle. It is profoundly broken.

Now KiwiSaver fund Simplicity and apartment and townhouse developer NZ Living have teamed up in a unique plan for Aotearoa-NZ: to build 10,000 homes worth $5b over 10 years with the sole aim of holding them and renting them out at affordable levels. In the process, they hope to expose the waste and hidden costs that currently make building flats painfully expensive.

This is not the way it’s done in a property development and sector dominated by booms, busts, litigation, short-term thinking and the overall aim to make tax-free capital gains on land price escalation, rather than building homes people will rent for years and years, possibly even decades.

Our current hodge-podge ‘stack’ of developers, mezzanine funding, sub-contractors, buy-and-flick owners, agents and increasingly disenfranchised and desperate renters believe it can’t be done an other way. They’re told and tell each other regularly that a chronic and permanent shortage of land, building materials, skilled tradies, reliable and affordable finance and the focus on homes as investments rather than places to live mean it impossible to build houses more affordably. These are the underlying assumptions behind all sorts of Government, Reserve Bank, Council and investor actions for decades. There is no alternative, we’re regularly told.

But is that true?

Last week on my When the Facts Change podcast on The Spinoff, I spoke to Simplicity CEO Sam Stubbs and NZ Living co-founder Shane Brealey, who have spent decades soaking in the industry’s norms and practices. Over the last decade they’ve disconnected themselves from those usual modes of operation to do things differently. Now they’re coming together with a plan to become one of New Zealand’s biggest home builders and owners, which is able to ride through the ups and downs of the markets to build and operate affordable and liveable homes for decades.

Effectively, they want to dismantle the ‘stack’ that currently dominates house building and find a way to solve the massive challenge our biggest cities face: building tens of thousands of new medium-density apartments and townhouses that cost way less to rent that the current crop, relative to incomes, and in a way that reduces climate emissions and creates stable, safe and nourishing communities.

They’re breaking the usual rules to do it.

Proposed Hinaki Street development in Auckland. (Photo: Supplied)

Simplicity is a not-for-profit KiwiSaver fund manager that has focused on keeping its systems and practices low cost since it launched in September 2016. It now has 75,000 members and $4b in funds under management, with members paying an average of $400 a year in fees, which it says means they save $30.2m a year in fees relative to other providers, that operate for profit, use intermediaries and expensive offline systems. Simplicity is now one of the default KiwiSaver providers and is one of the independents competing against the big four Australian-owned banks dominating the market. (Disclosure: I’m a Simplicity KiwiSaver member)

NZ Living was set up by Shane and Anna Brea

ley as an apartment and townhouse developer over three years ago using ‘Kaizen’ techniques to strip out waste and cost from a process dominated elsewhere by short-termism, competitive tenders, litigation and a type of winner-takes-all-zero-sum-game riven with distrust and opportunism. They will have built 720 homes over the three years to the end of 2022 with six of their own staff and a loyal group of sub-contractors and suppliers.

They have large-scale contracts to build homes for Kāinga Ora in Auckland. They don’t run tenders for projects. They don’t try to play suppliers and partners off against each other or try to circumvent local building materials suppliers. Instead, they focus on refining out cost and waste in both materials and processes. They pride themselves on not having groups of subbies standing around high-viz waiting for directions, materials and systems to get through the traffic jam at the gate.

They’ve gone out of their way to avoid a culture that has left dozens of developer, finance company, contracting, and sub-contracting collapses in its wake. Just Google Ebert, Mainzeal, Soho Square, Layne Kells, Mark Hotchin, Hanover Finance, Strategic Finance, Orange-H Group, Stanley Group, Bridgecorp and Tower Cranes. It’s the reason second-tier lenders charge double-digit interest rates on short-term interest-only loans that can explode in everyone’s faces if there’s a change of market sentiment, consenting delays or problems for apartment buyers getting funding from banks, who are loathe to touch the whole shebang with even the longest bargepole. It’s the reason contractors layer on cost at every opportunity to make up for the inevitable payment delays, litigation and collapses.

‘The music will always stop’

It’s the reason few want to build systems and train apprentices, knowing the bust is just around the corner and no one wants to be left holding the parcel of explosive debt, contracting bills and litigation fees when the bust inevitably arrives.

It’s also the reason no one in the sector takes a strategic or long-run approach to planning developments over decades. It is fantastic for:

• Construction industry lawyers and litigators;

• Mezzanine financiers hoping to lend high, repossess low and sell high;

• Buy-and-flick merchants using the natural leverage of apartment deposits and never-ending price increases to make property trading gains;

• Insolvency practitioners and agents able to set their own fees in the restructuring and sale of assets; and,

• Cowboy-boot wearing Ferrari-driving property developers with an excellent line in phoenixing their companies and timing their entries and exits to both take advantage of and then avoid the booms and busts.

When the dust settles, the only people left destitute are:

• The finance company investors holding worthless paper (see this ‘Deep Freeze’ list at Interest.co.nz I helped build from 2006 onwards showing losses of over $3b on debentures originally worth $9.3b;

• renters paying over 50% of their disposable income to live in insecure, poorly maintained and unhealthy homes that means their kids bounce from school to school and then into the Emergency Department with skin, chest and brain infections; and,

• employers in the likes of Auckland and Wellington who are mystified as to why they can’t attract staff to work in their offices or keep their existing staff from moving for cheaper rents and the chance of buying a home in Sydney, Melbourne, Brisbane and the UK.

“The construction industry is kind of like the finance industry — it's see a filo pastry of fees,” Sam Stubbs says in the podcast.

“What we worked out was that the money that we can provide, and the construction capacity that NZ Living can provide, is actually a very powerful combination,” he says.

Brealey began in the construction industry 35 years ago as an engineer fresh from Canterbury University and was lucky enough to study Kaizen techniques, often known as the Toyota Way, when working at LendLease, which builds massive amounts of apartments in Australia.

“I’ve been in that pyramid contracting spiral, lowest-price tender game,” Brealey says.

“That invariably means tendering at certain points, and the rest cascades into just a jungle of waste and confusion and waiting and overpricing and under delivery and poor outcomes,” he says.

He initially set up his own construction firm 15 years ago, but decided to created an integrated supply chain of sorts that included the design, financing and ownership of apartments and townhouses.

Brealey and Stubbs have done the calculations and believe their top-to-tail system of funding, designing, building and owning cuts out 35-40% of the cost of building these homes.

‘All about waiting and opportunism’

I asked Brealey why the rest of the industry had developed this way.

“Two words: waiting and opportunism. If you look at any construction site at any time, you can be a grocer, a fisherman, a whatever line of work, look at a construction site and tell me how many people are actually building that project, and how many are waiting, standing, talking, chatting, looking for an instruction, looking for approval, waiting for a drawing, and all that type of stuff. It has to be paid for,” he says.

“Which brings me to the second word: opportunism. If you're a quantity surveyor pricing as a subcontractor or building contractor, you're only guessing how much waiting you're going to have to do in delivery of your responsibilities and your trade or that construction project. And so you invariably put on as much contingency as you think you can get away with, whether you spend it or not.”

Inside SImplicity Living’s proposed Hinaki Street development in Auckland. Photo: Supplied

A filo pastry of fees

Strip out the waiting and opportunism and NZ Living can focus on the building.

“Michael Schumacher, his favorite thing was go kart racing rather than Formula One, because it was pure racing. And so what we're doing here is we're pure building,” he says.

Simplicity plans to create a rental management operation that offers much longer term tenancy agreements for homes designed to be rented, and lived in as communities.

“We intend to own these for 100 years and rent them affordably on very long term rental contracts. For 100 years, they got to be built really well. So actually it's not actually about saving costs. It's about building something to last,” Stubbs says.

“If you think about as an owner, what are we paying for? Well, there's no development margin, there's no financing margin, there's no unit titling cost, there's no sales costs, you add all of that up, and then you put efficient construction on top, you actually have a much lower cost of product as long as you're prepared to vertically integrate your own process, have integrity and have a long term view,” he says.

“We will end up actually owning a whole lot of homes that are incredibly high quality, but also incredibly good value.

“People say you can't do that, no one's done it. Well. We've done it in the finance industry with Simplicity. It's actually remarkably the same with NZ Living. You can do things much cheaper, but here's the trick, the secret sauce:

“Most people build development sell homes with a five year view at most. You just want to develop it and sell it to make a margin. So they start thinking about as a property asset, and I want property type margins for all that risk, right? We're derisking it by vertically owning it, the whole thing.”

Stubbs thinks of the build-to-rent business as similar to a fixed interest substitute.

“So rather than stick the money in the bank and get 1% return, instead can rent them out to people and get two or three times that over 100 years. That's a fantastic investment. For those of you who are financially inclined, it's like it's a perpetual and floating-rate inflation-adjusted bond.

“The instrument doesn't exist in the New Zealand market. You have to create it by creating long term rental streams. But if you do that, then from the investing point of view, it's a fantastic investment because it's a substitute for fixed interest investment.”

‘There are no constraints’

Stubbs and Brealey don’t see the same constraints on growth that others see, including:

• land shortages because of council restraints on residential zoning to keep infrastructure costs down;

• land shortages because land bankers have consolidated the available sections and dripfeed them into the market to avoid oversupplying and driving down prices;

• building materials costs because of global supply chain problems and a concentration of power and supply in the hands of Carter Holt and Fletcher Building;

• labour shortages caused by not enough drug-free locals and not enough migrants from the Philippines and India because of Covid and tighter migrant policies; and,

• a lack of institutional capital because high land prices and the unique tax advantages for owner-occupier and ‘Mum and Dad’ landlords make it uneconomic.

Brealey says land costs are not crucial for medium density developments where the land costs are around 15-20% of costs because of the large number of dwellings per section, relative to a standalone home.

“It's not a deal breaker. And there is ample land, particularly in brownfield locations throughout Auckland,” Brealey says.

‘Land, materials and skills are not constraints’

He says NZ Living and Simplicity had already been offered land packages big enough for 2,000 to 3,000 new dwellings in the week since its announcement.

“If you're paying 10% on 20% of your total costs. That's only 2%. Whereas in construction, that’s 50% part of the pie. And if you're 30 or 40% more efficient in that area, it covers most other issues you might be challenged with.”

I asked if there were any limits if there was an ambition to build hundreds of thousands of new homes.

“Sorry, I can't think of one,” Brealey says.

He points out that doubling in the cost of container transport and building materials only represented a 1.5-5.0%. increase in the total cost of a NZ Living dwelling.

“I think that what you're hearing from other quarters is a combination of hype and opportunism that comes from clients and developers that are perhaps aren't the client of first choice, having people pricing to them, enjoying this little phase.”

Stubbs says the longer term view is crucial.

“You need a very long term perspective. You need to have a lot of money and you have to have it more vertically integrated. You got to be prepared to control and own things, rather than get into this eternal fingerpointing that goes on in the industry, blaming someone else for the excessive costs,” he says.

Brealey sees the problem as less about quantity and more about productivity.

We've got one person doing what we used to have four people doing, and and the rest of the market probably takes eight people to do. Our labour costs and our labour number have plummeted as we've innovated and become more productive,” he says.

“A lack of productivity means you swamp sites with all sorts of people waiting for instruction or clear instructions as to what to do. So we used to have a concrete and carpentry gang building 86 homes, and would it be a gang of 130. Today, we've got a gang of about 40 to 45, building 129 departments where we stand today.”

NZ Living never tenders for anything.

“We negotiate with mature parties. We don't hold bonds. We don't hold retentions. We work together like any good relationship should? And why would you do business with somebody you didn't trust and have to hold retentions or have bonds with? So we've used predominantly one subcontractor and supplier per trade,” he says.

“For Simplicity, when we get to that 1000 a year, we'll probably only need two or three subcontractors per trade. And there must be 200 out there per trade. I'm guessing that we'll probably get first choice on the parties that we want because we're such low risk, predictable and enjoyable, pleasant sites to work on, when you're working collaboratively.

“Get all that hostility that is typical of the market, out of your day, far more pleasant to work in.”

Stubbs is blunt about the difference in approach.

“There's three magic words there: ‘we trust you.’ It's amazing what you get out of somebody when you trust them. This industry is so built on mistrust, margin-shaving and litigation and chipping each other. It's just rubbish.”

(Updated throughout to correct spelling of Shane Brealey. My apologies to Shane.)