Residential property is the new asset class to really super charge your SMSF, if you get it right.
It is a lumpy asset class, and not one that always fits comfortably into the portfolio construction process. Here we look at how including property can be made simpler.
FIRSTLY, GET GOOD ADVICE !!!
Talk to Jack Henderson at Jackh@equinex.com.au
Residential property has captured the hearts of many Australians as the ideal investment. Private residences are the nation’s largest store of household wealth, and property regularly tops the list of places Australians consider the best place to invest. We are fortunate with one of the most conducive taxation policy regimes in the western world to promote the investment in residential property by individual investors.
This popularity has seen the number of Australians who own rental property as investments soar. In 1995, the ATO estimates there were 385,000 property investors; but by 2010, that number had grown to 1.7 million – a four-fold increase in just 15 years.
This growth in property investment has proved a real challenge for financial advisers for a number of different reasons. Many investors fail to consider how a property holding will fit into their financial plans until after it’s purchased. Yet the effects on a portfolio’s liquidity, diversification and returns can be profound.
When the market is performing well, property appears a deceptively easy path to riches, but this can be far from the truth. The performance of different properties – even houses located in the same street – can vary dramatically.
Yet many investors, particularly those who have seen the price of their own home rise, are confident they understand the market well. West Australian advisers found this belief nearly universal in late 2006 after the Perth market soared 40 per cent in just 12 months. Similarly, many Melbourne-based advisers are encountering this belief as its residential market has posted three double-digit rises in just the past four years.
‘When the market is performing well, property appears a deceptively easy path to riches’
It’s an unfortunate belief that results in many investors failing to get qualified and independent advice, and relying instead on their own instincts. Each year, I see thousands of investors committing to properties with poor growth profiles, such as high-rise city apartments. These properties have a very low land component per unit and are built in tight, high-density clusters over relatively short periods of time. This segment of the market periodically experiences an over-supply of near-new units, resulting in poor investment outcomes for owners.
The fact that high-rise units are popular with investors demonstrates why advice is needed. What isn’t understood by these investors is that newly developed property prices are typically 20 per cent above their intrinsic market value, and this condemns many owners to years of poor growth. Inexperienced investors are often swayed by stamp duty savings, accelerated depreciation and the rental guarantees offered by developers; but these short-term financial advantages are immaterial compared to buying a property at its intrinsic value with the correct profile for market-leading growth.
While investor outcomes in the established property market tend to be better, we also see plenty of poor decisions. Sometimes these are based on the buyer’s pet theory or the “wisdom” of relatives and friends, but these mistakes can be just as costly.
Don't rely on these people who may seem to have your best interests at heart, but will always hinder your progress with their "good advice". Call Jack Henderson on +61 4 11 75 22 16 to get it right.
For instance, I doubt many of the investors in “blue-ribbon location houses” on Sydney’s lower north shore in 2003 expected anything other than solid capital growth. These properties were widely considered to be gold-plated investments, yet most experienced flat growth or price declines over the following four years – a rude and expensive shock for their owners.
During the same period, certain property types in other areas continued to perform, despite a sluggish Sydney market. Similarly, I remember the scepticism that surrounded investment in Melbourne’s inner northern suburbs around 2000-2001. A decade later and many of these suburbs have turned out to be star performers, with the locals incredulous at the prices their homes now fetch on the market.
Just like other asset classes, the bedrock of impressive property investment performance is rigorous analysis and research. Rising markets mask poor performers which are quickly revealed when the tide turns. Indeed, our analysis shows that less than 10 per cent of the properties listed for sale around Australia qualify as “investment grade”.
Investment grade properties have several characteristics in common, most notably: average growth rates of 7 to 10 per cent per year; a high propensity to sell within 5 per cent of technical market value in a recessed market; and strong, consistent tenant demand. We use a 14-stage factor-analysis selection technique to find these properties and then back-test their financial performance against our benchmarks.
For advisers looking to build a relationship with a property adviser, I would make the following suggestions.
First, anyone acting as property adviser should be professional, highly experienced in the industry and qualified as a real estate agent. Screen out anyone who doesn’t have these bare essentials.
Secondly, consider their advice model. Make sure it’s based not just on their experience but that it also comes from well-researched and replicable analysis. A top investment adviser should be able to articulate their investment model clearly and then demonstrate how it gets results.
The next step is to look at how your practice and theirs will work together. I feel it’s important to seek partners where each member of the network recognises the other professionals’ fields of expertise. So it’s a legal professional who advises on the structure of holding; the financial adviser who advises on the place property takes in a client’s portfolio and who sets the budget for their investment; and the property adviser who selects the property within that budget.
The final element is how to co-ordinate that advice, and for this, my point of reference is always the question: What is in the client’s best interest? The networks of advice that tend to work best are the “straight-referral” models – that is, models based on complete transparency to the client and without referral fees. No matter how well intentioned, I have found that referral fees open the door to practices which are not necessarily in the client’s interest.
Talk to Jack Henderson at Jackh@equinex.com.au or call Jack +61 4 11 75 22 16 to get it right
If your advisers network is focused on excellence in advice and in continually gaining guidance from thinking about what’s in the client’s best interest, your involvement with these types of arrangements will ultimately see all parties prosper.
Thank you Greville Pabst, CEO of WBP Residential Advice