Currently, the world is experiencing historically low-interest rates. So low in fact, there are even countries actually experiencing negative rates!
Sluggish economic growth leading out of the Global Financial Crisis has caused reserve banks across the globe to pursue an aggressive series of rate reductions with the hope of kick-starting their faltering economies.
But after 10 years of this strategy, interest rates have now gone so low it has left little or no room for further effective reductions. It would seem we have arrived at our low point and that’s where we’re going to stay for quite some time.
But while low rates are great for variable household mortgages or other loans, they are woeful when applied to savings accounts, term deposits and any other cash-related investment vehicle.
In fact, across the four major Australian banks, interest rates paid on term deposits held for 12 months and paid on maturity, average a meagre 0.85%
So investors who traditionally seek out these types of income-investments now have to find themselves an alternate avenue in order to generate revenue and, subsequently, pay regular, higher returns.
And probably the most obvious place to look is property. Well, obviously for the vast majority of mum and dad investors! Creating income from direct property investment isn’t too great a leap of faith for most Australians as they actually have an incredible love affair with all things property.
And not only as a place to live! When the ‘wealth creation bug’ bites, a direct property investment usually becomes the number one salve in which to soothe the itch!
I can assure you, having been an adviser for over thirty years I’ve certainly witnessed this deep affection first hand, over and over again. Investment properties it seems are perceived by the vast majority of ‘mum and dad’ investors as not only the most profitable but also, the safest, method of investing.
Yes, that’s right, the safest. To an average property investor, buying a property is akin to money in the bank. My own ‘field research’ conducted over many years has 99.98% of new investors rating the transaction of buying a direct investment property as a 3 out of 10 as far as risk!
Interestingly, on the other hand, share investment is often considered akin to gambling at its most risky, and in my experience was always rated as either a 9 or 10 on the same scale.
Why? Well, it most certainly begins with a woeful lack of basic knowledge regarding investing. Most people I’ve discovered perceive investing money as being a pretty complex and intimidating process.
And as share investment is certainly not part of any school curriculum, it means that the only ‘investment’ experience most people have is either putting money in a bank account or buying their home.
So when the time comes time to actually make an investment, ‘newbie’s’ will honestly believe that their owner/occupied experience puts them in good enough stead to make well-informed investment decisions. This is, of course, a classic example of investor hubris put to work!
And you can be certain that this hubris is well and truly understood by real estate salespeople and subsequently exploited like crazy! Just think property seminars! But that’s another story.
So are their other ways an investor can tap into the regular income and capital growth afforded by property without the massive outlays and ongoing costs associated with a direct standalone property purchase?
Well, fear not, because there are numerous ways an investor can add a property component into their portfolio without having to commit to buying one directly.
Providing access to all the good aspects of the asset class; such as regular income and capital growth, but none of the associated costs attributed to direct investment.
There are a number of ways you can have a property investment in your portfolio
So let’s take a look at two very common methods of investment;
- Listed Real Estate Investment Trusts (REITS)
- Unlisted property funds.
Property funds listed on an exchange are referred to as Real Estate Investment Trusts (REITs) or Australian REITs (A-REITs). And investors can buy or sell their shares in these funds at any time, thus making them highly liquid.
Along with REITS, also included within this category are property specific ETF’s
Alternatively, an Unlisted Property fund is not available on an exchange, like the ASX. They are often referred to as property syndicates as they involve the syndication of ownership of a single property or group of properties, to investors.
Unlisted funds specify the period an asset or assets will be owned – usually five to seven years – and most typically provide monthly or quarterly returns (referred to as distributions) which are based on the net rental income received from the tenants.
The fund’s assets are typically divested at the end of the term and the proceeds are subsequently returned to investors. And like all growth investments, there’s also the potential for making a capital gain.
Additionally, within this category, is by far the most ubiquitous product in the class; property funds that operate as Managed Investments. Often referred to as a ‘managed fund’, these bad boys are open for investment continuously and operate exactly the same as any mixed-asset or share-based MIF on the market.
They are typically part of the product mix of fund managers and are by and large accessed through a financial planner, although they can also be accessed sans advice, direct from a fund manager.
MIF’s are usually cited as having the greatest fees and least performance compared to the newer listed investments. Most certainly a relic of their longevity, it’s a stumbling block to investment but it’s slowly being recognised and rectified by managers. (This will no doubt form part of your due diligence)
Property funds can also be closed or open-ended.
Closed-ended means the number of units in the fund is fixed. No additional units are issued or redeemed during the term of the fund. This type of fund generally has lower volatility than a listed fund as the assets are usually valued once or twice a year and the unit price is updated at the time of valuation.
Open-ended funds are similar, except investors can enter or leave the fund, as there is a liquidity facility in place. Investors can withdraw their investment at designated intervals, usually monthly or quarterly but in some instances, depending on the style of investment, at shorter ad hoc periods.
Some important metrics for property investment
When deciding which property fund is best for you, there are several key metrics to consider. These are the drivers that can deliver stable rental income and, therefore increase the likelihood of attractive returns. They include:
Weighted Average Lease Expiry (WALE).
The average number of years property has secured a tenant(s). Quite simply, the more years the better it is. The number provides you with a level of assurance of continuous rent revenue, which quite simply equals certainty of returns.
The type of tenant who is renting the property will underline how effectively it can pay its rent. Tenants whose businesses are resilient against economic or political uncertainly are highly desired. These include government agencies, ASX-listed entities, multinational corporations, large grocery store chains and large medical operators.
As you can imagine, during the current COVID19 times some tenants are hanging on courtesy of Government payments and will most probably fold when these eventually cease. And this cessation of business on a reasonably large scale will certainly impact income production going forward.
Of course, the current economic crisis was totally unpredictable, but it does exemplify what is termed a ‘black swan’ event. These events are certainly far from a common occurrence but when they do happen, they certainly provide a salient reminder to investors what the term risk really means.
Asset Quality and Location
This is especially important if you are investing in a single asset fund. An asset’s location and quality determine its desirability and demand from tenants, which can translate into stable income and potential for rental growth.
So always keep in mind the old property mantra of, “position, position, position” If you were to ask for just one piece of advice prior to investing, that would have to be it.
Remember, a property development in Katherine NT, created to leverage off a mining boom, just doesn’t compare to the purchase of an office unit on Pitt St, Sydney, no matter how enticing the marketing materials look!
Is the investment with a trusted manager?
The fund manager is the entity responsible for overseeing the operation and financial management of the properties. Ideally, you want a manager that is experienced, has operated throughout several property cycles and has a strong track record of delivering returns to investors.
Again your due diligence is important here, as track record can be the difference between success and failure with property investment. Experience really does pay dividends.
So how are the different types of property currently performing?
There are no pure residential A-REITs on the ASX. The most common form of ownership of residential is by direct investment. Compared to commercial properties, residential investments typically have shorter leases (usually six to 12 months), ambiguous and inconsistent quality of tenants, and higher overheads with lower income returns.
According to Domain Group’s June 2020 Rent Report (2), median rental yields for houses across Australia’s capital cities were 3.75% and 4.22% for units.
So if you’re looking to access residential property in Australia, the only avenue is buying it directly, which is by far a greater outlay than through managed products.
Interestingly, a couple of years ago a prominent financial planning group activated a float for the purpose of creating a dedicated residential property ETF, focussed on the US market. The idea being that this market was well and truly beaten down coming out of a deep recession caused by the GFC.
And as the US system allows for a return of the house in order to eliminate a loan, there were many banks that now owned houses and were eager to divest themselves of them. Thus a fund willing to buy them, at greatly reduced rates was certainly appealing.
Unfortunately, the fund, having launched, eventually ran into troubles on a number of fronts, not least the amount of hidden fees factored into the product. Those keen to understand some of the pitfalls to avoid as an investor can click here to read all about it.
And some further information regarding the trust, it now seems that ASIC has taken a rather keen interest in the fund and are launching a major best interests action against them. It would appear this funds days, if not already, are about to be severely numbered!
It does however provide a particularly vivid reminder that as an investor we should never just accept the flowery sales spiels and colourful brochures as gospel. Always do your own research, and if it doesn’t look right to you, forget it!
If there was one area that has probably suffered the most during this pandemic it would have to be retail property. Isolation and social-distancing restrictions commencing at the start of the year have limited shoppers from physically buying in-store. Consequently, retail shop lessees are finding it harder and harder to meet their rental commitments.
The COVID period has escalated the growing decline retail precincts and according to KPMG, there has actually been an 8.1% cumulative decline throughout three years to March 2020 (3). A predicated further fall to 11.7% is forecast throughout 2020. Additionally, research showed mall vacancies have reached a 20-year high, rising 5.1% in June 2020 from 3.8% in December 2019.
However, on the other hand, online shopping has been steadily increasing year-on-year, creating a positive impact on logistics and warehouse property. It seems that online retail sales have grown on average $2 billion year-on-year and as at year-end, reached have $30 billion (4).
Therefore, the pandemic is claiming yet another victim; retail property returns. A concerning turn of events as this may take years to fully recover, or in fact, never recover to the previous levels as shoppers become more and more used to online shopping.
And the more times a person uses online purchasing, the greater their trust in the concept which is oft-quoted as the major stumbling block for mass take-up.
Therefore, which way consumers will turn, either embracing online purchasing fully or, return to bricks and mortar, are going to be critical factors needing careful consideration prior to investment!
There has also been a number of actions regarding rent relief between some of the larger retail brands and the mega shopping centre landlords. In some of these cases, it has actually escalated into store shutdowns which are by any measure a very dramatic solution.
So if you’re considering a closer look at this sector, make sure you read widely about the current retailer/landlord battles, as any decision by retailers to begin an exodus towards total online distribution will certainly impact ongoing rental income.
Which means they may be ‘cheap’ not because of the current COVID19 effects, but rather, because of a possible long term profitability issue.
These are the large properties that house storage, manufacturing and logistics tenants and are typically between 5,000sqm and 20,000sqm. They normally located along the key transport corridors, such as road arterials, rail freight lines, shipping ports and airports. They are usually let on five to seven-year leases although a purpose-built facility will attract longer terms.
It would seem demand for this asset class has been growing significantly in recent years due to the growth in e-commerce and its need for well-located warehouses to service customers.
However, a note of caution, because ‘just in time’ manufacturing principles are permeating more and more within large suppliers, thus smaller orbital facilities may be where the growth drivers are for this type of property.
But according to JLL research, the average vacancy rate across Australia’s Eastern seaboard states was 3.8% at 2019 year-end. And throughout 2019, and it was retail that accounted for 22% of industrial take-up, behind transport, postal and warehousing.
Offices are exactly that, office space. All those large office towers dotting every city landscape from Sydney to New York. These have always been the mainstay of indirect property investment products and have certainly experienced strong investor interest over the past couple of decades.
Because skyscrapers attract multiple tenants (just take a look at the many and varied tenants on each floor of your standard city high rise) they’re extremely well-diversified, which means income generation isn’t reliant on just one company.
Remember, successful investment portfolios are always well-diversified, and office REITs certainly has this trait in spades! And with most rental agreements or lease terms running between three to ten-year durations there is strong and reliable cash flow.
Importantly, the current global pandemic certainly needs factoring into any investment analysis. It appears that the COVID19 virus is reshaping exactly where the workforce is working from. Home-based work has now become somewhat ‘de rigour’ for those that can accomplish it creating a veritable wasteland of high rise office space strewn across most cities.
Recently in order to kick start a pretty sluggish economy, workers have started to return to their offices in most cities. (Except currently Melbourne) And there has certainly been plenty of negative press coverage regarding future demand in the office letting space as a result.
Currently, office space does have a mid to long-term positive outlook but this could certainly change as we become mired down in a long term fight against COVID19.
However, as an aside and certainly more whimsical, the cynic in me strongly suggests that the ‘working from home’ concept strongly precludes a number of key management machinations that are rife within the ranks of the bigger companies.
Therefore, cost savings and productivity gains aside, middle management ranks have lost their direct audience for the constant posturing and manoeuvring, so very important to successful office politics.
A ‘zoom’ meeting may carry all the hallmarks of a fruitful interaction, but it does lack that immediate personal touch available to the traditional ‘face to face’ get together.
Consequently, the blatant ‘brown-nosing’, fawning and total consensus afforded by underlings to their superiors, can’t really be accomplished!
And sadly, modern managers seem to thrive on this constant stream of fake and contrived compliments, allowing their better judgement to be totally superseded by the ego-stroking afforded by their staff.
So, unfortunately, any productivity, efficiency, or profit gains offered by a ‘home-based’ workforce, for me anyway, will soon succumb to that ubiquitous trait present in all management ranks, office politics.
Therefore returning the workplace back to its ‘intended’ purpose will take precedence in order to return it back to its original purpose; a place of personal fiefdoms and Chinese walls enabling management to fully indulge their inherent psychopathic behaviours!
Finally, there is Healthcare property which is obviously medical facilities – primary care premises, such as GPs rooms and medical centres; secondary health, such as day hospitals; tertiary health care facilities such as private hospitals; allied health such as dentists and physiotherapists; and ancillary health, such as pharmacies and childcare provisions. These assets are typically held in unlisted funds.
Now accordingly MSCI’s research up to the end of December 2019 the hospital market yielded around 6.11% whilst medical centres returned 5.97% for the same period. Now obviously compared to term deposits at this time these returns are pretty good and being supplied by what could be described as a blue-chip industry across all sectors.
So unless we miraculously stop getting sick we’re certainly going to need more and more of these properties into the future and particularly as the population ages and suffers the more chronic modern lifestyle disease such as Type II diabetes and heart issues.
Additionally, healthcare assets can attract 10 to 30-year lease lengths, depending on the nature of the asset which provides investors with a long term surety of a growing income stream well into the future – a very appealing feature for any investor.
Here’s a bit more detail regarding healthcare property investment which is certainly worth reading. Click here.
As with any type of investment, property comes with risks. But as I suggested earlier, the investing public doesn’t seem to recognise those risks. Or, if they do, they certainly don’t see the full extent of them.
Yet, property can certainly fill the income gap left as a result of low-interest rates and most importantly adds diversification into an investment portfolio and subsequently lowering overall portfolio risk – which is a good thing.
But like all investing, make sure you do your research and above all realise that nothing is infallible so be prepared for failures. And remember; seek the advice of a licensed professional to assist your investing should it all seem just far too complex. Professional advice can often make the difference between an effective portfolio and a non-performing one.
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Update 20th August 2020 And just to be reminded of the risk associated with any investing activity, here’s an article about a property fund manager who’s just had one of their key assets repossessed. Again, always do your research before embarking on any investment. Click here’s to view the article.