Property has always been a principal wealth creation vehicle for Australians, particularly residential property as ‘Bricks & Mortar’ has always being considered secure. There are five main forms of property to invest in that include residential, commercial, retail, industrial and the tourism property sector. Investing into property can be by way of direct investment or indirect investment dependent upon an individual’s own circumstances.
Property can create wealth by the expected increased value, the income generated and the tax benefits available.
The other key issues involving property investment include tax and social security implications, borrowing to invest, being able to manage the investment and understanding the various risks and advantages associated with each type of property sector.
Direct Property Investment
Direct property investment means investing and owning a specific property through the acquisition of its legal title. Direct property that may be suitable for investment will depend upon the investor’s needs and preferences involving the five categories available that all have different risk and return characteristics:
Residential - includes private dwellings and flats/units for rental. Commercial - includes offices and business administration type buildings Retail - includes shops and shopping centres.
Industrial - includes factories and warehouses.
Tourism - includes hotels, motels and resorts.
The Advantages of Direct Property Investment are;
Property is a tangible asset that can be seen and touched, unlike other investment classes. Capital appreciation over the longer term generally exceeds inflation, depending on location and maintenance level.
Tax deductible expenses may include claims for depreciation, repairs, maintenance, insurance and financing costs.
Rental incomes are broadly linked to inflation and, while property is tenanted, are reasonably certain due to the existence of lease agreements. No capital gains tax is payable on the sale of a principal place of residence (residential property).
The Disadvantages of Direct Property are;
Valuation – property valuation is more of an art than a science. Many judgmental decisions are required to arrive at an assessed value, which ultimately can only provide a guide to whether a given property is good or poor value relative to the asking price. Even professional valuers’ judgments should only be taken as an estimate.
Research – the decision to invest in property is research intensive. Obtaining reliable data on residential property markets prior to investment can be very difficult. This is largely because the outlook for residential property varies from city to city, suburb to suburb, street to street and from house to house. Consideration should be given to the economic environment, property cycle (the bottom of the cycle is the optimum time to invest), property location, property condition, tenant mix and/or lease agreements.
Ongoing capital expenditure – capital expenditure will usually be required every 3-5 years to keep a property up to date. This is in addition to ongoing repairs and maintenance.
Liquidity – property is not a standardised product. When purchasing a property, time is needed to inspect the property, become familiar with the local market and compare the value of comparable local properties. This usually means that property is an illiquid asset (that is, can not be sold quickly).
Management – unlike other asset classes, direct property investment is very management intensive either by yourself or via a property manager or agent. It can be an expensive, intensive, frustrating and emotionally upsetting experience. Management involvement extends to the procurement of tenants, collection of rent, physical repairs to the property, improvements to the property etc. This is a very important factor with respect to residential property and it being untenanted at a time when you are fully or partially dependent on that rental income (for example, in retirement) needs to be considered.
Minimum costs – any well balanced investment portfolio should contain exposure to property and if the size of the portfolio is sufficiently large enough then direct property exposure may be warranted. However, to obtain sufficient diversification within the property market would require the purchase of several properties spread across different locations and different property markets. Given the high relative cost of individual properties, this is usually out of reach of most investors. Transaction costs – any purchase or sale of real estate involves a payment of legal fees, estate agent fees, stamp duty, valuation fees etc. These are usually quite high relative to other financial assets.
Ongoing costs – property is subject to various ongoing costs such as repairs/maintenance, building insurance, rates, land tax and management fees. These are usually quite high relative to other financial assets. Ongoing costs such as repairs/maintenance, building insurance, rates, land tax and management fees can represent a significant proportion of gross rent. While these can often vary greatly, a typical figure for these could average out at 20% of gross rent over the long-term. This may mean that net rental income is not as high as that available from other financial assets. It could also mean that rental income will be negative during times of large expenses.
Professional fund managers do not generally invest in residential property due to a combination of the above factors and the likelihood of better returns being available elsewhere. Lack of diversification means that investors are subject to greater risk as most investors already have a large exposure to the residential property market through their existing home so to purchase an additional residential property provides them with little diversification. The time required to sell a property at an acceptable price can be substantial, depending on the relative ‘buoyancy’ of the local market at the time. If a quick sale is required, a substantial amount of money can be lost.
Indirect Property Ownership
Indirect property ownership is a means to acquiring an interest in property by way of ownership of share/s, through a trust vehicle or by syndication without having actual control of the legal title. Generally there are two forms of indirect property ownership, Listed Property Trusts & Companies through the ASX and Unlisted Property Trusts via private treaty and or timeshare.
Listed Property Trusts and Companies
Listed property trusts and companies (either directly or through a managed fund) are a means to gain access to non-residential property. These offer professional management, a spread of properties, geographic diversification, liquidity and lower relative transaction costs. The advantage of a listed property is that it is subject to the stricter legal requirements of the ASX. Many offer tax advantages, greater diversification, liquidity and lower relative transaction costs.
Unlisted Property Trusts and Companies
Unlisted property trusts and companies and an alternative form of property investment. This class of property assets may be more diverse than the mainstream property assets but are not subject to the same strict regulatory control of the ASX.