Making the right investment and asset allocation decisions has always been challenging - even Warren Buffett doesn’t always get it right. But when interest rates are at near zero, markets volatile and world economic growth sluggish, investors desperate for yield they can live on, face real challenges.
Asset allocation used to be far more straightforward than it is now - the formula was simple, and was applied universally. A large allocation to growth or ‘riskier’ assets, like equities and property, during the working years, and a move into more conservative assets, like cash or fixed interest, as retirement grew closer.
The problem investors face now is that the lower risk assets, like cash, simply can’t provide a sufficient income stream. At the same time, taking on a whole lot of risk in the hope of higher returns can mean capital preservation is at stake, and that isn’t a good outcome either.
With a unique combination of yield and potential capital growth, commercial property could be just what investors need now.
Unlisted property trusts – yield and the possibility of capital growth
Unlisted property trusts which invest in high quality commercial property have the potential to provide investors with a yield they can survive on, as well as the possibility of future capital growth.
Unlisted trusts pool investors’ money to invest in quality commercial assets which would not be accessible to individual investors. The income from rents in the properties is distributed as income throughout the life of the trust. At the end of the trust period, the property is usually sold and any capital gain divided among investors. This does mean that investors’ money is tied up for the length of the trust, typically between five to seven years, so it’s important to understand that during that time it can be difficult to exit.
Returns on offer from well-managed, quality unlisted trusts can be appealing. Ongoing yields of between 7-8% compare favourably with 2-3% from residential property, and total returns of between 12-13%, and in some cases more, over the five or seven-year period look pretty good on any measure.
All trust managers are not the same - look carefully at the track record
In Centuria’s view, active management of the property assets in an unlisted trust can have a significant impact on returns. For example, our in-house asset management team is tasked with constantly seeking ways of better managing our portfolio as well as identifying ways to increase rents by making improvements to properties which will appeal to potential tenants. These can be initiatives such as upgrading foyers and lifts, improving air-conditioning and undertaking ‘spec’ fitouts in order to attract smaller tenants and improve a property’s tenancy profile. A well-managed, quality property will attract good tenants, ensuring security of underlying income to investors.
When looking at specific property assets in an unlisted trust, the weighted average lease expiry (WALE) of a property is also very important to consider. The WALE measures the average time period in which all leases in a property will expire – and given that these leases underpin income streams which make up the yield, the longer the leases are locked in the better. In most cases the longer the WALE, the more secure the income stream and potentially the higher the price of the property when it comes to sale.
A-REITs are another option
Listed property trusts are another option. Because they are listed, they are more liquid and easier to move in and out of. However, unlisted property trusts are more closely tied to the value of their underlying property assets than their listed counterparts (A-REITs), which tend to move more in line with equities than property markets.
At the same time, because an unlisted property trust is not priced daily by the market, it is very important that the manager is transparent about how properties are valued, and how the fund’s net tangible assets (NTA) are calculated. A good manager will disclose all information about how assets are priced, the extent of any borrowings, as well as fees and charges.
That’s why it’s important to assess each individual property trust carefully. In property, as in any investment, the more you move up the risk curve (or down the quality curve) in the expectation of a higher return, the greater the risk of getting burnt. It’s crucial that investors choose a manager with a strong track record of success, and which provides clear detail about the reasons for the purchase of a particular property as well as how it is expected to perform over time.
Ultimately? Juggling risk and return is difficult
The risk versus return conundrum investors now face is, in many ways, more complex than it has ever been. Too much risk can spell disaster, but in a world where term deposits are barely keeping up with inflation, investment options which can provide a liveable yield within reasonable risk parameters, are very much in demand. Of course, every investor’s situation is different, and asset allocation decisions must take into account individual risk profiles and investment horizons – but advisers and investors would do well to look at including unlisted property in the mix.
Jason Huljich, unlisted property funds chief executive, Centuria