There’s no doubting the popularity of investment in residential property however there’s also a wide range of property sub-sectors which could boost investment returns while helping to balance risk. We weigh up some of the options.
It’s tangible, practical and can be enjoyed on many levels – residential real estate is not just an investment. It’s little wonder then that self-managed super funds (SMSFs) are increasingly adding residential investment property to their portfolios.
The average SMSF boosted its exposure to the sector from 5.6 per cent in 2012 to 9.9 per cent in 2013, according to the latest SPAA and Russell Investments SMSF report1. Meanwhile, about one-third of SMSF trustees say they are considering investing in residential property while more than two-thirds of financial advisers say such investment decisions are being driven directly by SMSF clients2.
But while residential property is a well-known, comfortable investment for many Australians, there is also a world of property that extends beyond the backyard.
APN Property Group chief executive officer, real estate securities, Michael Doble says a diversified portfolio invested in listed Real Estate Investment Trusts (REITs) can spread an investor’s risk across a range of commercial property assets including retail, industrial and office assets.
“That has to be a lower risk proposition than being exposed to one tenant in one asset in one location, which is what you're getting with your residential exposure,” he says.
Professionally-managed commercial property-focused funds typically produce higher yields and lower growth than residential property assets, making it an ideal diversifier in a portfolio. Yields of 6-8 per cent (compared to residential property’s 2-4 per cent) are underpinned by longer-term leases with a range of major companies and government departments3.
While most investors are readily familiar with the negative gearing benefits which apply to residential investment property (SMSFs are partially able to gear their property investment under strict limited recourse borrowing arrangements), REITs can have their own tax advantages.
A portion of distributions usually attract a tax deferred component, which reduces the cost base of the investment, effectively delaying tax to the time when the REIT is sold. It means that a well-managed REIT fund with low turnover can delay some of its tax payments.
While managed funds charge ongoing investment fees, they compare favourably with the cost of employing a property manager while also offering a more liquid investment, according to Doble.
“You can't sell the back bedroom of your investment property,” he says.
Australian REITs’ weighted average gearing is now approximately 32 per cent while interest cover (earnings before interest and tax over interest expenses) is about four times, according to SG Hiscock portfolio manager Grant Berry. “It’s very healthy,” he says.
The diversification benefits of property can also be boosted with an offshore exposure.
“It's a far larger market than Australia,” says Doble. “It's one that is growing quickly and the assets are invested in markets that are experiencing stronger growth than Australia – Asia remains the growth engine of the globe.”
“An investor should think globally because the opportunity set is so much larger,” says Berry. “Property is a local asset class so they're performing differently in different markets at different times.”
However, Berry also notes that global REITs are generally yielding less than Australian REITs (approximately 4 per cent versus 6 per cent).
Residential versus Australian REIT funds: a comparison
| Residential | REIT fund | |
|---|---|---|
| Yield | 2-4% | 6-8% |
| Tenants | Individuals | Corporations, government bodies, ASX listed companies |
| Lease terms | 12 months | 5+ years |
| Gearing | Up to 90% | 20-50% |
Source: APN Property Group
1 Intimate with Self-managed Superannuation report by SPAA and Russell Investments. February 2014.
2 Intimate with Self-managed Superannuation report by SPAA and Russell Investments. February 2014.
3 APN Property Group.