ASX-listed Aspen has found novel ways to combat the cost inflation plaguing the sector. It’s time to scale via M&A and create sustainable operators.

By Justin O’Brien
Source: Financial Review
May 30, 2024

Australia has an abundance of space. However, most of us want to live close to a few large cities. It is this simple fact that has created significant wealth for those lucky enough to own property. For others, the Australian dream has become unattainable.

Despite all the rhetoric, governments can’t and won’t be the panacea for our housing affordability crisis. Like all complex problems, we need multi-faceted solutions, and the corporate sector has an important role to play.

Housing affordability is at its worst level in 20 years and is expected to decline further. Supply, as measured by new housing starts, is at cyclical lows. However, demand via migration remains high (for now) and demographic trends continue to shift the type of housing needed. This has led to very low vacancy rates for rentals with the likelihood that rents will trend higher, further stoking the inflation fire.

In a recent presentation to investors, John Carter and David Dixon, who are the joint chief executives of Aspen, a developer and operator of affordable housing, put numbers to the problem. They highlighted there were more than 4 million households with an annual income of less than $90,000 requiring affordable housing, which they defined as under $400,000 to buy or less than $400 per week to rent.

However, building accommodation that meets these criteria is extremely challenging given the high cost of land, building materials and the labour needed to construct – let alone taxes, which are a very high proportion of the cost of new builds.

Each of these costs has risen substantially since the onset of COVID-19 and remains stubbornly high. Given the many and complex reasons underpinning this inflation, it is difficult to see them falling soon. Perhaps governments will once again lean on subsidies to offset these high costs. But for how long should taxpayers bear the brunt?

Our view is clever corporates, operating under a profit motive, are one solution to the problem. Aspen has deployed some novel approaches that government can only dream of using, such as buying sites from receivers, or acquiring difficult assets that require repositioning or capital spend to bring them up to scratch.

In an interesting contrast to recent government announcements to demolish and rebuild large apartment buildings in Sydney and Melbourne, Carter and Dixon highlighted the portfolio they purchased in Perth in 2019. Aspen paid $52 million at the time for 17 properties, many with very high vacancy rates. Their most recent refurbishment within this portfolio was the Maylands apartment complex, near the Perth CBD. Aspen paid just $58,000 for each apartment, which at acquisition had just 38 per cent occupancy. By spending $131,000 on average, on both the apartments and surrounding area, Aspen has significantly improved the units’ “liveability”, which has driven occupancy to 100 per cent with the University of Western Australia now an anchor tenant.

For investors, this renovation has generated a circa 50 per cent return on investment.

Had Aspen simply knocked down Maylands and rebuilt, it might have taken five to 10 years to obtain planning permits and complete construction. Not to mention the vast waste of concrete, steel and other energy-intensive materials, or the eventual high rental cost, well outside the affordable level, needed to earn an adequate return.

But novel approaches, while necessary, are still not sufficient. To be a low-cost service provider, it is essential to have a low-cost position yourself.

That doesn’t just mean providing a service efficiently. Scale is often a vital factor in achieving a low-cost position as it dictates a “structural” level of costs. For housing operators and developers, this includes overhead costs like marketing, operations and administration where bigger translates to lower overhead costs per unit.

For rental providers, the corporate operator owns the bricks and mortar, which is a capital-intensive game. Being listed has an advantage in sourcing capital. But listed companies also benefit from scale. Bigger stocks often enjoy a lower cost of capital – a fact the real estate investment trusts have taken advantage of for many years.

Given the scale benefits of both operating costs and capital costs to the sector, mergers and acquisitions should be encouraged. Scale achieved via M&A will ultimately lead to better outcomes for consumers and assist in creating long-term sustainable operators.

This is one of the reasons we supported the proposal to merge Aspen with the sub-scale operator Eureka. We were substantial shareholders in both companies until we converted our Eureka shares to Aspen shares. The logic for creating a more scalable business is obvious. Despite the deal’s rejection by Eureka shareholders, Aspen remains well-placed to build on its position, while also delivering value for Aspen shareholders.

To us, this is the essence of a sustainable operator and is at the heart of our investment philosophy which seeks good-quality companies, run by management teams/cultures that have a proprietorial or ownership mindset, with the opportunity to create value longer-term in industries with tailwinds.

Justin O’Brien is a portfolio manager at Cooper Investor.