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Look to commercial property for yield

Richard Stacker
— 1 minute read

With Australian interest rates at historic lows, investors who are searching for yield would be well advised to consider direct property, says Charter Hall’s Richard Stacker.

Richard Stacker

With 12-month term deposits (TDs) at around 2.6 per cent, the question on every investor’s mind, if not lips, is ‘yield’.

The days of being able to park a sizeable lump of one’s savings in the bank via a TD and feel content that your money is both safe and working for you seems like a distant memory.

Sure it’s a safe option but is it working for you? Hardly.

As advisers know only too well this is one of the reasons the big four Australian banks have had such a lacklustre performance lately.

The recent pull back courtesy of absolutely flat results from Westpac and CBA only heightened the focus on yield.

Many commentators would still argue banks are a good play in defensive and (fully franked) yield at current levels, but the banks will have to convince the market about their capacity to grow future earnings to resume their ‘market darling’ status.

In this current low interest rate environment, savvy investors and advisers need to review both asset allocations and individual equity selections.

One particular asset class that has garnered a lot of attention has been residential property. Increasingly this sector is associated with descriptors such as 'risk', 'overvalued' and 'bubble'.

This is one area where the yield focus has taken a back seat to low borrowing rates and an expectation of ongoing capital gain.

Yield on residential property is generally sub three per cent after taking account of both transaction and holding costs and, very often, substantially so.

Once land tax and allowances for future repairs and maintenance are taken into account the result can quite often be zero or negative running yield. In other words the investment becomes a capital gain play only.

Most investors would be aware of warnings from both the Reserve Bank and ASIC on the risks of excessive borrowing to fund residential property investments, especially by SMSFs.

The asset class that has tended to be overlooked in many discussions within and beyond the media is the opportunity in commercial property.

The reasons for this are not readily clear. Certainly I believe the risk and returns are worthy of broader scrutiny as is the opportunity cost of ignoring them.

Real estate investment trusts, commonly known as REITs, are one such investment class where these type of property assets can be accessed.

The pluses include the expectation of consistent yields, currently averaging around five per cent, liquidity, as REITs are listed on the Australian Stock Exchange and, often, the prospect of capital appreciation.

On the other side of the equation the price of REITs usually correlate closely with the share market movements, thus introducing the issue of volatility and, in recent times, they have tended to trade at a significant premium to the underlying value of the property assets.

The other avenue for investors wishing to add high-grade commercial property to their investment portfolio, or SMSF, is direct property, also known as unlisted property trusts.

A seven per cent yield on an unlisted or direct property fund equates to a 40 per cent advantage on, say, a REIT showing a five per cent yield.

Direct property also has the attraction of being less volatile than REITs and shares.

Of course, there is an offset. Direct property is less liquid than REITS.

Many direct or unlisted funds do have regular liquidity events, or liquidity windows, where investors can apply to redeem some of their investment.

It must be said, however, that direct commercial property funds are designed as medium-term, solid return investments.

They should not be considered to be in the liquid basket of an investment portfolio. That’s what cash, near cash and listed securities are for.

Direct property funds do offer an expectation of capital growth over the life of the fund, which is generally around the five-year mark, as well as regular returns.

Liquidity, yield, volatility, total return and, of course, security of the investment will always be the key issues for investors to consider and determine which mix is right for their individual circumstances.

The bad news for investors and advisers alike is the consensus of expert opinion which predicts this low yield environment has many years to run. The good news? There are higher-yielding quality assets out there.

Richard Stacker is the head of Charter Hall Direct.

 

Look to commercial property for yield
Richard Stacker
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