Financial Planning and Property Investment

Direct Property Investment is typically a residential dwelling held for rental income.

  • Residential real estate provides a lower income yield for higher capital growth
  • Non-residential real estate provides a higher income yield for lower capital gains
  • Property Trusts are passive investments that provide asset class and geographic diversification by location, tenant and asset sub-class, reducing risk
  • Direct Property investments are illiquid and as a single investment offer no diversification
  • Any form of property investment should be part of a carefully considered and clearly documented Investment Plan, prepared by a licensed Financial Planner.
Property Investment

Direct Property Investment v Property Trust Investment

Investors contemplating property investment have a range of options to consider. Choices include whether to buy residential, or non-residential real estate, such as retail, commercial or industrial property. Another investment decision is whether to buy Direct Property, or property held within an ASX-listed Property Trust or an unlisted Property Trust.

Direct Property Investments

The most common Direct Property investment made by everyday Australians is residential real estate, to earn rental income that us used to pay down the mortgage loan taken out to acquire the investment property. Other Direct Property investments may comprise retail, industrial and commercial (office) real estate, although it is rare for Australian investors to acquire property assets of this nature. Australians are familiar with residential real estate ownership, whereas non-residential property is a specialist area with added complexities, and generally a higher capital cost.

Residential real estate generates a substantially lower rental income yield than non-residential real estate. There are several reasons for this lower yield. Firstly, the capital cost for residential property is typically higher than non-residential property, primarily because the land value content of a residential dwelling is often, but not always, higher than the land content of non-residential real estate, because of the services and amenities that are found in residential areas. Another reason is that residential property valuations, unlike non-residential property valuations, are not based solely on economic or capital return metrics.

Residential real estate has an added dimension to its valuation and that is ‘aesthetic’ appeal. This means that factors other than economic value or rental income drive the capital cost of residential real estate. This has the effect of increasing residential real estate value above its valuation based solely on rental yield. Residential real estate typically yields between 1 and 3 percent per annum compared to non-residential real estate where the yield may vary from 3 to 6 percent per annum. This partly explains why low yielding residential real estate often delivers strong capital growth, compared to non-residential real estate which typically compensates investors with a high-income yield as a trade-off for comparatively lower capital growth.

Another factor driving and sustaining residential real estate values, compared to non-residential real estate values is that a dwelling which is the principal place of residence of a resident taxpayer, is exempt from Capital Gains Tax (CGT). This generous tax concession is known as the main residence exemption and means that the family home is the only source of tax-free capital gain (apart from cars and personal use assets costing less than $10,000) in Australia. This is a key driver that supports house prices relative to other property assets, which are subject to CGT where a profit on disposal arises. Of course, a residential property from which rental income is derived, does not meet the CGT exemption.

However, the point is that Australians are incentivised to acquire a home as their main residence from an early age knowing that the capital growth, when realised on disposal of the property, is exempt from CGT. This concession explains the premium attached to residential dwelling prices in Australia, relative to all other assets, and not just property assets.

Property Trust Investments

Property Trusts typically comprise retail, industrial or commercial real estate investments that are held collectively and can be listed or unlisted. Property Trusts often comprise properties with a focus on yield. This is because industrial, commercial, and retail properties are leased to businesses seeking to maximise earnings by being in locations that generate the highest business returns as tenants. Furthermore, non-residential real estate generates taxable income in which case tenants receive a tax deduction for the rental expense paid to the landlord.  For example, retail properties tend to be in high population density areas that are conveniently located for shoppers. Commercial property which generally refers to office buildings are typically located in central business districts close to public transport routes that enable workers to travel daily to their workplace. Industrial property is often located at or near heavy transport and distribution hubs to facilitate the efficient movement of goods or the provision of industrial related services.

There are several advantages of Property Trust investments, compared to Direct Property, including diversification by location, tenant and asset sub-class, which reduces risk. Property Trusts can be considered passive investments in that the investor isn’t actively involved in buy/sell/hold decisions or management decisions relating to the properties, freeing up time and effort. On the other hand, Direct Property investment requires time and effort in managing tenants and property maintenance and leaves an investor with concentration risk, particularly where exposure is limited to (say) a single property. Property investments held directly afford total control to the property owner, whereas control of a Property Trust is in the hands of a Corporate Trustee, which is governed by Directors who make decisions on behalf of the unit holders.

Similar tax deductions are available whether investing in a Property Trust or holding property assets directly.

A common misconception among Property Trust investors is that listed Property Trusts offer liquidity in that investors can sell their units on the ASX and liquidate their investment. This is true in that investors can sell their units; however, this is often at a discount to the underlying Net Tangible Asset (NTA) backing per unit of the Trust. This is because a Property Trust cannot offer any more liquidity than is afforded by its underlying assets. This is why ASX listed Property Trust units often are traded on the ASX at a discount to NTA.

There is no liquidity in owning Direct Property either, without selling the property. However, this is well understood by investors in Direct Property investments who are long-term investors. Direct Property investors often consider that capital gain is compensation for the lack of liquidity.

Financial Planning and Property Investments

Whether property exposure is through direct ownership or indirect ownership through a diversified Property Trust, any investment decision should be part of a carefully considered and clearly documented Investment Plan.

An Investment Plan should consider factors like an investor’s existing and future income requirements, risk appetite, time horizon (years to retirement), tax position and tax implications and the amount of capital available for investment.

If choosing the Direct Property route, research is important while looking for ‘value rather than glamour’. A dwelling is a depreciable asset, so discerning residential property investors often seek out land-rich properties, because it is the land content of a property that generally rises in value more so than the dwelling structure.

Listed and unlisted Property Trusts are complex investments that require a research-driven approach to optimise risk and reward outcomes for investors.

A licensed Financial Planner can provide assurance that property investment decisions are appropriate for individual investors’ needs and are consistent with investors’ financial goals.

GET IN TOUCH

    Make better financial decisions with our newsletter packed with tips and
    information about trends and opportunities.

    Call Us Today! 07 5444 0675