Direct property: a low volatility pathway to asset growth

By Steven Bennett

March 02 2018
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As the heat continues to recede from Australia’s east coast residential property markets, advisers and investors are turning their attention to other real estate options and opportunities.

Direct property: a low volatility pathway to asset growth

Specifically, the focus is increasingly on the investment-grade commercial property sector, where income yields of around 6 per cent p.a. are on offer and total returns (including capital growth) in the order of 9-10 per cent p.a. are expected.

The large superannuation funds and life assurance companies typically hold 8 per cent to 15 per cent of their portfolio in commercial property, and more and more individual investors and SMSF members/trustees are following suit.

At the same time many investors, and the professional investment community generally, have experienced somewhat of a shock: a significant sharemarket correction led by the US stock market, which other major bourses followed.

Suddenly a market characteristic that seemed to be on everyone’s back burner because it has been so benign for so long, namely volatility, is front and centre.

While equities markets seemed to have settled somewhat, the strength of the US economy and the potential of rising interest rates globally means investors and savers are on edge.

One question facing those building their nest egg who are looking to emulate the big super funds by allocating monies to investment-grade commercial property have to consider is: what type of property investment to make?

The two major options are direct property funds, also known as unlisted property funds and real estate invest trusts (REITs).

My firm, Charter Hall, is one of the largest and most successful participants in both markets, with almost $22 billion under management across all forms of commercial property including both the aforementioned types of funds plus wholesale funds, private syndicates and wholesale partnerships.

One of the major differences between the two forms of trusts or funds is liquidity. REITs are listed on the ASX and consequently are highly liquid. Their values tend to fluctuate in line with the movements in equities generally. Thus REITs may trade at above or below net asset value depending on prevailing equity market sentiment. Importantly, they are also subject to similar volatility to the ASX and most pundits are now predicting increasing volatility going forward.

Direct property funds on the other hand are relatively illiquid for the period of the fund, generally five years. They are a ‘buy and hold’ asset and should be funded out of one’s non-cash bucket. Charter Hall direct funds, and many others, will usually have regular limited liquidity events to give investors in need of cash the opportunity realise a part of their holding, but the actual amount may be rationed depending on the number of people wishing to cash out.

One of the attractions of direct funds is that they are valued daily and the values reflect the underlying assets. Also, they have very low volatility, especially compared to REITs because they are not subject to the normal fluctuations of the equities markets. For many investors this is a particularly attractive characteristic and it is one that is likely to attract much greater interest as investors contemplate the immediate market outlook and the return of volatility.

I am constantly asked what form of property fund do I recommend? Direct, with its low volatility and generally longer-term holding and the prospect of around 9-10 per cent p.a. total return; or REITs, which can be liquidated by a call to the broker but whose value may be higher or lower than actual net assets depending on the stock market mood at the time.

One of the soundest rules of investing is diversification. My first advice is to consult your adviser, planner or accountant. My second observation is it makes sense to have a mix of both based on your individual circumstances and needs.

Steven Bennett is head of direct property at Charter Hall.

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