Recently, there has been a lot of coverage in the broader press about investing directly in property through your SMSF. However, returns from residential property have (on average) been disappointing over the last two years.
RP Data – Rismark in its Home Value Index noted an aggregate decline in home values of -0.4% in 2012, following on from a -2.8% decline in 2011. Gross rental yields on houses for the year were 4.3%. That’s 4.3% before expenses. If you factor in real estate rental fees, insurance, repairs and maintenance, vacancy, etc. the yield falls considerably.
So if property investment is to make sense, investors are obviously forecasting large capital gains on their property. Yet few are predicting significant house price increases in the short to medium term.
The overlooked story
What is also often overlooked in the property capital gain “story” are the costs incurred in order to achieve any capital gain. While a property survey may show a house price increase from $400,000 to $450,000, it does not take into account the cost of stamp duty, the real estate agent fees, the capital costs of any improvements, legal fees etc.
Taking a step back, the capital gain ‘story’ is based on the assumption of a capital gain! The NAB quarterly Australian Residential Property Survey (for December 2012) forecasts modest growth of 1.5% through to the end of 2013, with a similar gain forecast for 2014 – hardly the sort of capital gain needed to offset the low net running yields provided by property. With interest rates already at historically low levels, there are not too many independent commentators suggesting a housing boom will happen any time soon.
There is also the question of if you’re investing in property via your super fund, are you intending to sell the property to realise the capital gain? Or do you simply plan on using it as a steady stream of income? If the latter, is a gross return of 4.3% really producing a strong enough income for your retirement?
An alternative through RMBS
So what is the alternative if your want to have a property exposure in your SMSF but want potentially higher income returns? RMBS (Residential Mortgage Backed Securities) are a type of debt security secured by a pool of home loans.
Typically, home loans are illiquid and private in nature, however by combining them into a large and diversified pool and then breaking the combined pool into smaller, marketable classes, the RMBS become attractive to investors who would otherwise be unable to take exposure to the underlying sector.
The concept of breaking the pool into varying classes of securities allows investors with specific risk appetites to target the appropriate class, and thus returns they are seeking. In this way, the classes act not unlike a normal company capital structure, where investors with the lowest risk appetite target the senior bonds (or in the case of RMBS, the highest tranches) and those with a higher risk appetite target the lower ranked capital, like hybrids or equity (or in the case of RMBS, the lowest ranking tranches).
What’s on offer? Taking a risk adverse view of the Australian housing sector, an investor in high quality AA-rated RMBS can currently achieve returns around 7.5%. This is a relatively low risk ‘tranche’ of RMBS. The less ‘bearish’ you are with the Australian housing sector, the more risky the ‘tranche’ (lower rated) you may choose to invest in and, subsequently, the higher the return on offer.
If you want to hold exposure to residential property in your SMSF, RMBS may well provide a better alternative and better still, there’ll be no calls from your tenants to fix the plumbing!
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
