Real Estate

3 ways to get started in commercial property

By Christopher Davitt
Portfolio Manager Sydney, Australia

Commercial property is an attractive sector for SMSF investors but the entry points are not obvious for anyone without a spare $20 million-plus available to buy a building.

There are plenty of options in commercial real estate for SMSF investors outside of the extremely high net-wealth bracket.

The three most common ways to own commercial property are to directly own it or to invest in a syndicate or open-ended fund.

Each has its pros and cons.

Direct ownership

An enduring appeal of real estate is that it’s tangible and investors often simply like owning something they can see. There are, however, practical limitations to direct ownership that need to be considered. Directly owning commercial property inevitably involves writing a pretty big cheque and for most investors this would take up a sizeable portion of their total life savings.

Let’s use an investor with a total investment portfolio of $1 million as a case study.

A quick search of a few commercial property websites shows that $1 million doesn’t stretch very far. Many investors with $1 million would rule out direct ownership of commercial property on the basis that it represents a heavy concentration in one asset and requires them to put too many eggs in the one basket.

Another consideration is that fact that small commercial properties are often occupied by a single tenant and if that tenant leaves or goes broke the property won’t be producing any income.

No investor wants an empty property but for some SMSF investors there can also be unfavourable tax consequences if the property isn’t producing enough income.

Furthermore, commercial property requires a great deal of time and expertise to manage even if a property manager is retained. Finding the right property to buy, appointing a leasing agent, considering any environmental issues, building regulations and legal action are often beyond the remit of the property manager and therefore left to the owner to sort out.

It requires a considerable investment of time as well as money.

Syndicates

Syndicates help overcome some of the issues associated with direct ownership. A syndicate is when a group of investors come together – or are brought together by a professional manager – to buy property and sell it a few years later.

By pooling funds together, individual investors can better spread their risk as the minimum commitment for syndicates is commonly as low as $100,000. What’s more, often the syndicate will purchase more than one property in more than one market, which also spreads the risk.

Many syndicates have the added advantage of being professionally managed, which takes the hassle out of commercial property ownership. Of course, this comes at a price. Costs can include legal, accounting, banking, management, and real estate agent charges upon selling.

Still, syndicates have been well supported for a long time – particularly in recent years while the market has been rising and interest rates have been falling. Many investors see the value of professional management as out-weighing some additional costs.

Another important feature of syndicates is that they almost invariably use 30-50% debt (also called gearing). This changes the risk profile of the investment. When things go well and returns are strong, they will be even stronger if debt is used. The flip side, however, is that negative returns will also be magnified and investors may not recoup all of their capital when the property is sold.

Investors are locked into the syndicate from the time they sign up until the time the properties are sold. The advantage of this structure is that there is no pressure to sell assets during the hold period. The disadvantages are there is a lot of pressure on the manager to buy property in the investment period, which can lead to over-paying for assets, and there is a lot of pressure to sell during the divestment period even if it’s not a good time to sell.

Open-ended funds

For investors wanting to minimise transaction costs and maximise diversification while maintaining access to their money in a low-debt vehicle, open-ended funds may be a good option.

As the name suggests, these funds don’t have a finite life and are able to accumulate their assets over years, indeed decades. This helps them to minimise the impact of transaction costs.

As these types of funds buy assets for the long-term, these costs have long since been expensed and are not paid by new investors. Similarly, as there are no establishment costs, some funds don’t charge a buy spread or an entry fee to come into the fund.

The ability to accumulate assets during the long-term also gives open-ended funds greater diversification. A syndicate will typically hold a single property, maybe a few more. Open-ended funds can grow to own 20 or more properties and might have a few hundred tenants on the rent roll. This minimises the exposure investors have to any single tenant.

For SMSF investors with an account-based pension, a well-diversified income stream and ability to keep their tax-exempt status, is important.

The scale of open-ended funds also means that they do not need to use much debt. The target level of debt for a typical syndicate is around 40-50%, compared to less than 25% for the AMP Capital Wholesale Australian Property Fund.

The distinguishing feature of open-ended funds is that investors can choose when to invest and when to withdraw their money. To allow this – and for other reasons – most open-ended funds maintain an allocation to listed property securities. This does, however, introduce some share-market volatility to the portfolio.

The good news is that investors have choice. These funds are often available to SMSF investors with as little as $10,000.

Final thoughts

The steady income stream that commercial property can offer suits a lot of investors. But more than any other asset class, deciding to invest is only the beginning.

The investment vehicle you choose is likely to play a big part in determining how much risk you’re taking on, what your returns are and whether you can access your money when it’s needed.

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Important notes

While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455)  (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

Important information:

National Mutual Funds Management Ltd. (ABN 32 006 787 720, AFSL 234652) (NMFM) is the responsible entity of the Wholesale Australian Property Fund and the issuer of the units in the Fund. To invest in the Fund, investors will need to obtain the current Product Disclosure Statement (PDS) from AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232 497) (AMP Capital). The PDS contains important information about investing in the Fund and it is important that investors read the PDS before making a decision about whether to acquire, or continue to hold or dispose of units in the Fund. Neither AMP Capital, NMFM nor any other company in the AMP Group guarantees the repayment of capital or the performance of any product or any particular rate of return referred to in this information. Past performance is not a reliable indicator of future performance. While every care has been taken in the preparation of this information, AMP Capital makes no representation or warranty as to the accuracy or completeness of any statement in it including without limitation, any forecasts. This content has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. Investors should, before making any investment decisions, consider the appropriateness of this information, and seek professional advice, having regard to their objectives, financial situation and needs.

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