With the cash rate at only 2.5% and the Reserve Bank of Australia (RBA) arguably still on an easing bias, income-oriented investors face a more pressing quandary as to where to generate income. Term deposits, while the safest investment, no longer cut the mustard in income terms.
This is particularly the case for self-managed super funds (SMSFs) looking to diversify their income sources from the main game in town, bank-share dividends.
Increasingly, they are finding this in commercial property investment, which many seem to be viewing as a combination of asset allocation to property and income source.
Unlisted property attracts
And in this twin role, unlisted property is emerging as an attractive proposition – at the expense of the listed Australian real estate investment trusts (A-REITs) sector.
Kevin Prosser, research manager, Direct Assets, at Lonsec, says “the pendulum has swung back a bit” to a preference for unlisted investment.
“The A-REIT market is trading at a slight premium to net asset value (NAV), particularly the bigger trusts. If you take out the Westfield pair, and Goodman, which tend to skew the figures, it’s about a 3% to 5% premium. With the valuations a bit stretched, investors are looking much more closely at the yield picture.”
This comparison “markedly favours unlisted trusts,” he says.
“In the listed REITs, you’re looking at about 6% to 6.5% for FY14, with a bit of tax advantage. In the unlisted market, the average is about 7% to 7.5%. If you’re in an industrial property, that’s probably a bit higher, so the range you’re looking at is more like 7% to 9% pre-tax, with higher-risk properties even in the double figures.”
The tax advantages for unlisted vehicles arise from the significant building and depreciation allowances on new buildings, which are effectively passed on to investors as tax-deferred income. This provides cash flow benefits because tax-deferred income is generally not taxable when it is received, but is deferred until the investment is sold: the investor will pay more capital gains tax (CGT) on the way out.
Yield boost
“If you have a new property, if you’re getting a 7% to 9% pre-tax yield from the syndicate, a lot of that is tax-deferred on the income. You’re not paying any tax on that income in the near-term, and effectively you can gross that up to be 8.25% to10.5% for an SMSF in accumulation. Compare that to the listed REITs, where you’re getting 6% to 6.5% with not much tax advantage, the yield comparison is substantially in your favour in terms of income in the unlisted sector,” Prosser says.
When the unlisted property market “froze” in 2008, at the height of the GFC, many trusts froze redemptions.
“After that, investors were prepared to pay a premium for the liquidity of the REIT sector,” says Prosser.
“But now that the unlisted market has come through its problems, liquidity is not seen as the major issue, and investors are prepared to take the risk of not having liquidity – or as much liquidity – to get that greater yield.”
To meet this demand, unlisted property trust managers and syndicators have returned to the market, says Ken Atchison, managing director of specialist property investment consultancy Atchison Consultants.
“The likes of Abacus, Sentinel, Folkestone, Fortius, Centuria and Cromwell Property Group have all released products this year. Cromwell, in particular, came out with some syndicate offerings based on very simple, good long-term leases to government tenants, in new buildings, so [there are] high tax advantages. There was a lot of demand and a lot of groups have climbed on the bandwagon.”
The risks
Unlisted property funds and syndicates typically run for a defined term of about three to seven years, but can be longer. It can be very difficult to get an investment back before the term expires. Closed-ended funds are illiquid, meaning the investment is locked up for the entire term. Other funds can be open-ended, meaning there may be the option to sell part of your investment, on say a monthly or quarterly basis.
Increasingly, says Atchison, the market is seeing property groups working with the accounting firms and the financial planning dealer groups that advise SMSFs, on tailored syndicates offered to particular groups.
“They will divide the asset into smaller, more manageable sizes of investment, say $100,000 to $200,000, instead of having to buy the whole property yourself for $1 million. That’s a chunk that many SMSFs can afford, and the SMSFs are realising that they don’t actually need liquidity. They are now more prepared to hold inert property exposure, as a long-term hold and a pension funding source.”
The trade-off, he says, is that the unlisted trusts and syndicates generally work in the area of lower-quality assets than those owned by the REITs.
“Investors must do their homework on the quality of the building, and the quality of the tenant is just as important, to satisfy yourself that the projected income stream is reliable,” he says.
Listed options
For those who prefer the liquidity – and the ‘half equity’ profile of the share market – there are still some exposures that offer a bit of added attraction for their yield. Broker RBS Morgans, for example, says its preferred exposures are:
Cromwell Property Group (CMW), which gives investors exposure to office property, with a particularly long profile of weighted average lease expiries – which is important, given current challenges in leasing markets. RBS Morgans expects office rents to remain under pressure in the medium term, given increased vacancies. Consensus FY14 forecast yield 8.2%.
Bunnings Warehouse Property Trust (BWP), which, as the name suggests, mostly holds Bunnings Warehouse properties. The broker says good-quality industrial assets should also see solid tenant demand continue from internet retailers, large retailers and other businesses seeking to achieve scale benefits in their logistics infrastructure. Consensus FY14 forecast yield 6.8%.
Generation Healthcare REIT (GHC), the only listed REIT that invests solely in healthcare assets. The portfolio of seven properties includes hospitals, medical centres, laboratories and other purpose-built healthcare facilities. Consensus FY14 forecast yield 6.4%.
APDC Group (AJD), the only listed REIT that owns data centre assets. AJD has a portfolio of two operational data centres in Melbourne (M1) and Sydney (S1), and another under construction in Perth (P1). AJD has one tenant, data system operator NEXTDC Limited (NXT), under long-term leases. (NXT hived off and floated AJD in January of this year.) Consensus FY14 forecast yield 8.8%. RBS Morgans says GHC and AJD both offer exposure to niche sectors with high barriers to entry.
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