Your checklist for finding income in commercial property
With Australia’s record-low interest rate sitting at 0.10%, many Australian Mum and Dad and SMSF investors are struggling to find income in a ‘lower for longer’ world. Cromwell’s Head of Retail Funds Management, Hamish Wehl, shares insights into the current investment landscape and considerations for SMSF investors.
In early September 2021, the Reserve Bank of Australia (RBA) maintained interest rates at their historic low of 0.10%. Low interest rates are part of a suite of policies known as quantitative easing (QE), which are designed to support the economy through the COVID-19 pandemic.
However, while the economy has bounced back quickly after each lockdown there are clear signs a full recovery will take some time. Even before the COVID-19 pandemic, there were close to 2 million Australians out of work or underemployed and in 2020 Australia experienced its first recession in 30 years as the unemployment figure reached 2.5 million.
Unemployment peaked at 8% in December 2020 and though it has now fallen to 4.9%, lower wage growth and a shortfall in consumer demand has led to RBA Deputy Governor Dr Guy Debelle making it clear rates will remain at ultra-low levels until at least 2024.
What does this mean for investors?
The current investment environment is presenting several challenges for investors. So-called ‘risk-free’ assets such as cash and term deposits are generating record low, and in some cases even negative real returns. Government bond yields have plunged, and the coronavirus jolt to the market saw high-yield bonds behave more like equities.
In addition, COVID-19 has forced companies to reassess dividends and many of those who rely on banks, for example, have seen their payments reduced. As a result, investors are having to reconsider old models of portfolio construction and look elsewhere for assets that deliver regular, reliable income.
When looking for income, however, it is important not to forget the fundamental principles of investing. Even in a time of major economic upheaval, when the returns produced by all asset classes have been affected, having a diversified portfolio remains important. While it may be tempting to move up the risk curve, for example by increasing a portfolio’s allocation to equities, this can magnify losses when equity markets fall.
And at a given point in time, when one type of investment is performing poorly, another is often performing strongly, so diversification can help to smooth out peaks and troughs. For investors who are relying on their portfolio to meet their lifestyle needs, diversification can also help to preserve capital and ensure there is not an over-reliance on one source of income.
Where should investors look?
In a market where returns from income producing investments have been impacted, property can be a valuable addition to a portfolio.
Property has consistently been a popular asset class with investors seeking stable income, diversification, and some capital growth potential.
Throughout the pandemic, undoubtedly a period of significant market uncertainty, the Australian commercial property sector has continued to deliver a consistent (albeit conservative) income return of 5.0% (for the 12 months to 30 June 2021). Over ten years, the figure is more impressive, with income of 6.2% p.a. annualised and total return of 9.4% p.a. annualised, demonstrating the sector’s propensity for consistent stable monthly income with some capital gain upside. (1)
The most accessible and cost-friendly approach for investors to access commercial property is through ASX-listed Real Estate Investment Trusts (A-REITs) or unlisted property funds.
- A-REITs are professionally managed portfolios of listed properties which can be traded daily on the ASX. The value of A-REITs change in-line with broader equity market sentiment, which can cause the value of the investment to be more volatile than a direct investment in property.
- Unlisted property funds provide an investment with characteristics most like a direct purchase of a commercial property, with the added benefit of professional management. Unlisted funds offer lower volatility, given the price is based on the underlying valuation of the property assets and is not directly influenced by equity markets.
As the hunt for income continues, many investors are including professionally-managed unlisted property funds in the investment consideration set.
Before investing, it is important to get to know the investment manager and ensure the underlying assets will deliver the stability and income required.
When assessing a property investment, there are a few key areas to consider:
- Management: Does the manager have the right depth of experience and past performance?
- Distributions: Do distribution forecasts seem reasonable? What level of tax deferral is available? Tax deferral can substantially increase an investor’s after-tax returns.
- Assets: Are the assets in the portfolio well located? Are the buildings of a high quality with sound green credentials (which are becoming increasingly important to tenants)?
- Tenants: Are the tenants reputable and able to pay rent even in difficult times (for example government or blue-chip companies)?
- Trust structure: Is the trust fixed term or open-ended? If it is fixed term, are you willing to invest for the full term? What happens at maturity?
- Fees: Are the fees and costs you are paying in line with market levels?
For more information about Cromwell’s funds, contact Cromwell’s Investor Services team at email@example.com.
(1) Property Council/MSCI Australian All Property Digest Q2 2021: www.msci.com/web/msci