The easiest way to explain commercial property investment is through the great Australian love affair with residential property. Everyone’s familiar with residential property; you buy an apartment or a house and rent it out. Depending on what and when you’ve bought over the past few years you’ve probably done well. There’s been solid increases in prices and the added benefit of negative gearing along the way.
The uglier truth is the rental income yields from residential property are generally pretty miserable – it’s not uncommon to get less than 2% per year after all expenses.
While interest rates are low and while commercial property yields have reduced over the past few years and values have risen, commercial property as a general statement offers a much higher rental yield. Annual cash yields of 6-7% are still available today with well established businesses and governments as your tenants, typically much longer leases and with the tenants bearing most if not all the running costs mentioned above. There’s also the prospect of capital and income growth in addition to the regular income yields we are talking about and the commercial property sector has a very good long-term performance record.
What sorts of assets are we talking and what are the used for? The last time you went to a meeting in an office building, stopped to fill your car up, had a trip to hospital or ordered that new pair of shoes online chances are you were using a commercial property. We are talking shopping centres, warehouses, hospitals, childcare centres, office buildings, data centres and the list goes on!
Next is “Hey, I’m not Frank Lowy or Donald Trump – how can I afford an office block?” Just as friends sometimes band together to buy a residential property, unlisted property trusts allow a group of investors to pool funds to buy commercial real estate. Each owns a slice of the property just as a group of friends might own a portion of a house. You can invest in a commercial property fund from as little as $1000 and receive a regular distribution payment. A lot of commercial property trusts will also pay a good percentage of the distribution as a tax deferred distribution –the income you receive reduces your original cost base rather than that year’s taxable income which can provide a tax benefit.
The other key difference is while residential property is often funded with up to 90% debt, commercial is usually much lower – 20-50% is typical and this is very important when it comes to thinking about investment risks.
Property trusts offer professional, independent management and clear financial objectives and reporting. Our job is to find great properties and make it easy (and profitable) for our investors.
Reasons for the rise in unlisted property
Firstly, falling interest rates have made life difficult for income investors. Unlisted commercial property usually delivers a more stable and comparatively higher income than conventional assets like shares. As rates have fallen, commercial property yields (although they have fallen too!) look more attractive.
Secondly, investment income derived from rents rather than fluctuating corporate profits is more reliable. Compared to listed asset markets, commercial property is less volatile. Income investors like that. If you think of owning the office building leased to the bank rather than owning the bank which occupies the office building you can see the monthly set rents they are paying under a long term lease are typically much more reliable than the profits to bank shareholders who take the good with the bad.
The other thing attracting people to our sector is that you are investing in ‘real’ assets – that is, you can go and touch or kick them, they have a real, physical value. People like the idea of investing in ‘bricks and mortar’ and it can provide a good hedge against inflation.
As to why unlisted investments are increasingly attractive versus listed investments, I think a lot of it is to do with people’s views on the correlation of their returns with other asset classes such as shares. Unlisted investments are not readily tradeable like shares on the ASX, so there’s not the same volatility in pricing. An unlisted investment is valued periodically by an independent expert valuer. Unlisted investments are typically held for five or more years without the option of selling on a day to day basis. Some people will like seeing a nearly constant ‘market value’ of their investment while others are content to invest for the five years, collect the income and sell the asset at the end.
For these reasons, over the next five years I think the popularity of unlisted property assets will continue to increase. Given my job, you might expect me to say that, but I also think it’s true.