Many investors assume that all property investment is the same. It isn’t, and you should ensure your clients know the difference before taking the plunge, says Greville Pabst.
It’s a regular dilemma for financial advisers; one which seems to crop up when the stockmarket takes a hit.
Investors scared by a sudden disruption to the market call their adviser with a terse instruction to sell their shares and switch their super and investment trusts into 100 per cent cash, fixed interest or property.
Many investors assume that these asset classes are as simple as their names and that all assets within them essentially offer the same outcome. But as we all know, “fixed interest” and “cash” don’t mean what the everyday investor assumes, because each of these asset classes contains a variety of different assets trading on different markets.
We in the property advice business experience exactly the same tribulation. That little slice of a balanced super fund or investment trust portfolio pie labelled “Direct Property” brings up a number of connotations for the average Australian, creating a perception that they can be reluctant to let go of.
The everyday investor reads in the newspaper that property has gone up – or is about to go down – and they tend to believe that their property slice has the same investment fundamentals and outlook as their home. But the cold, hard truth is it doesn’t, and financial advisers should ensure their clients know the difference.
‘ ‘Fixed interest’ and ‘cash’ don’t mean what the everyday investor assumes’
Of course, the first distinction to be drawn is that between commercial property and residential property – and it’s quite a distinction. For a start, residential property has an eight-year history of short supply; and while sales results may fluctuate over a short-term period, the long-term yearning of Australians to rent, invest or buy a residential home shows little sign of faltering.
A case in point was the most recent negative year – 2008. Even though interest rates reached a decade high of 9.25 per cent in the first half of that year, and many economic commentators were predicting double-digit falls, ABS house price figures showed a decline of just 3.1 per cent. And while some are already of the opinion that 2011 will be a weak year for the residential property market, based on lower sales clearance rates, they tend to ignore the fact that so far this year there has been a greater volume of successful sales than in all but one other year in the past decade.
However, while residential property is historically the everyday Australian’s chosen real estate investment choice, improvements in commercial property markets following considerable post-GFC turmoil are attracting a growing number of everyday investors to the sector.
Commercial real estate – classified as property assets primarily used for business purposes – consists of three sectors: retail, office and industrial. Each of these sectors includes a range of assets and has its own cycle, representing often very different risks and rewards.
Attracted by strong yields, when compared with residential property, a flood of “mum and dad” investors utilising self-managed super funds are investing in small commercial properties, including mixed-use dwellings, such as a retail shop with dwelling, small industrial factories, strata titled offices, retail strip shops, fast food outlets and service stations.
Although some commercial properties offer investors yields akin to residential property – around 4 per cent – others can achieve a return of up to 10 per cent, after costs, depending upon the asset class and risk rating.
The benefits of investing in commercial property are that it is characterised by longer leasing covenants than residential property (typically three, five or ten years) with fixed or CPI annual increases, and the added benefit of the tenant meeting the cost of all outgoings – in some instances including land tax, if the tenant is publicly listed. Furthermore, commercial tenants generally take better care of a property, ensuring it is maintained and presentable. But while sometimes also offering potential for high capital growth, the high return from investing in commercial property is not without risks.
Historically, the commercial property sector is far less predictable than residential markets, with the potential for longer vacancy periods and poor resale for some specialised assets, influenced significantly by economic factors such as unemployment and consumer confidence. In recent times, investment in the commercial sector has become increasingly difficult, being subject to stricter lending conditions that require buyers to have a minimum 30 to 50 per cent deposit.
As commercial property of all kinds tends to be built in bulk, large increments to new supply can often lead to periodic oversupply in a location or across an entire state, which takes time to work through and puts a cap on capital growth.
While most forms of commercial property tend to have a supply-demand equation much closer to the balanced mark, many capital cities currently have an oversupply of office space with vacancy rates hovering around 6 per cent.
Australia’s retail sector is also under pressure at present as sales flounder due to a high Australian dollar and a jump in online consumer purchases, adding further pressure to the commercial sector.
For the everyday investor diversifying into residential or commercial property, the principles of property selection may seem quite obvious. But dig a little deeper and they will quickly discover all is not as it seems. Surprisingly, only around 10 per cent of properties deliver consistent, reliable growth in every phase of the market’s cycle – very specific property types in very specific locations.
