If your SMSF contains residential investment properties, it’s understandable you could be feeling nervous. Australia’s house prices have fallen for 13 consecutive months, with average Australian capital city prices now down 4% from their peak. The once booming cities of Sydney and Melbourne have led the falls over the last year; while falls in Perth and Darwin, which started several years ago as the mining investment boom ended, have continued.
Add to this, changes proposed by Labor that, if elected, they will reform negative gearing by limiting it to newly-built properties and halve the capital gains discount for newly acquired assets, and residential property investment could look a lot less attractive as an asset class in the future.
For those looking for a real-assets based alternative, it could be time to consider commercial real estate, which offers steady inflation-linked income, diversification benefits and the potential for capital growth.
While commercial and residential real estate have delivered a similar investment return of around 10% over the last 20 years, the profile of those returns varies significantly. Investors in residential real estate have benefited from significant capital growth, while commercial real estate returns are predominantly income based. This makes commercial real estate particularly attractive for investors moving into retirement.
What is commercial real estate?
Commercial real estate is a diverse asset class encompassing property assets such as office buildings, factories, warehouses and shopping centres. This diversity of asset types means there is something to meet the risk appetite and return expectations of most SMSF investors.
It is also possible to construct a portfolio of commercial real estate assets that can benefit from key demographic and economic trends, such as investing in health care facilities to capitalise on the impact of the ageing population or investing in data centres to profit from the growth in data usage. The income of these assets will typically be underpinned by contractual leases with the largest operators in these growth industries.
The benefits of commercial real estate
As an asset class, commercial real estate offers capital growth similar to equities but is relatively high yielding like bonds.
The risk profile of commercial real estate assets varies greatly. For example, a capital city-located office building with a large corporate or government tenant on a long-term lease is a relatively low risk investment in contrast to an office building in a regional center with vacancy or refurbishment risk.
Institutional investors have been investing in commercial property for decades for the following reasons:
- It typically offers annual income of around 5-6%, which institutions consider attractive for the level of risk involved.
- Real estate has a low correlation and behaves differently to other investment asset classes, providing diversification within an investment portfolio.
- Unlisted real estate asset values are less volatile; they don’t go up and down on a daily basis like equities.
- Even though there can be good and bad years, in the long-term both the value of assets and the income they generate tend to keep up with increases in inflation and the cost of living.
- They like the diversification it offers – while company profits swing up or down year-to-year, the rent companies pay is usually fixed by the lease and usually rises each year.
How to invest in commercial real estate
For most individuals, there are some practical difficulties in buying a commercial property including a high minimum buy-in, on-going management of the property and navigation of legislation and regulations to do with its operation and leasing.
But there are more accessible ways to invest in commercial real estate. You can invest in listed real estate via the stock exchange or unlisted real estate either directly or through a real estate fund or trust.
Investing in listed real estate requires a smaller capital outlay, as you’re buying an equity, and offers higher liquidity (the ability to sell your investment), but the value of your investment is also subject to stock market ups and downs, particularly in the short term.
Conversely, unlisted real estate involves a larger capital outlay (wholesale trusts typically have a minimum investment of $10 million) and has lower liquidity. But the investment returns are less volatile and have a low correlation to other asset classes.
An alternative, which combines both listed and unlisted commercial real estate assets, is to invest in a retail real estate fund, which typically has a minimum investment value of around $10,000. By combining both listed and unlisted assets, an unlisted retail real estate fund can offer great diversity and the contrasting volatility and liquidity profiles of listed and unlisted real estate complement each other.
However, ultimately, the best mechanism to invest in commercial real estate will depend on each individual’s risk appetite, return and liquidity requirements and investment horizon.
To learn more about investing in commercial real estate, watch our recent webinar.
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.