by Jason Huljich

Property has much to offer the self-managed superannuation fund (SMSF) trustee. In fact, it has been suggested by some commentators that the voracious appetite of SMSFs for residential property has contributed at least in part to recent spikes in house prices in major capital cities.

According to Jason Huljich, CEO of Centuria Property Funds, there is more to Australians’ desire for property than just our well-documented love of bricks and mortar.

SMSF trustees, like most investors, understand that diversification is key to reaching long term financial goals. Reducing risk by choosing to invest in asset classes which do not move up and down in tandem but respond differently to the same market events minimises the chance of portfolio-wide catastrophic losses and helps improve overall returns.

With this in mind, even though Australians may be hard-wired to seek out property over other investments, it is actually smart investing to make some allocation to property within a diversified portfolio. Returns from property tend not to be highly correlated with other asset classes, and as such, property is particularly well suited to delivering real diversification throughout the investment cycle.

For SMSF trustees, property has some specific attractions. It offers stable yields, often tax-advantaged, as well as the potential for capital growth. And given that investments in superannuation are already tax-advantaged, when the tax benefits associated with yields from property are added to the mix, it’s no wonder SMSF trustees are embracing the sector.

However, given that so much has been written about SMSFs’ focus on residential property, is it possible that they are ignoring potentially better property options in favour of the one they feel more comfortable with?

Clearly, as managers of unlisted property trusts which invest in commercial (largely office) property, at Centuria we have a preference for commercial over residential property. But there are a number of good reasons for this.

The first is the yield from commercial property, which is currently sitting in the range of 8-9% p.a. Yields from residential property are closer to 2-3% p.a. Both provide some measure of protection against inflation, because lease payments are generally inflation-linked, but in the case of commercial property, this link is much more explicit in the terms of the lease.

This often isn’t the case for residential property. Commercial leases also tend to be more ‘locked-in’ than residential leases, more difficult to break, and in quality commercial premises, tenants are generally businesses far less likely to default or seek to break their leases than the average residential tenant. This means that returns are more stable and cash flow more certain, an attractive proposition for all investors.

When it comes to capital gain, many SMSF investors clearly believe that the potential capital gain from residential property will be higher than that from commercial property, thereby offsetting the difference in yield. In our view however, this is not necessarily true. In fact, it can be the case that investors are drawn to residential property simply by virtue of the fact that they own a home themselves so believe they understand it better, which makes it less risky. Unfortunately, a look at the overall returns from both sectors shows very clearly that things don’t always work out that way.

So for investors looking to invest in commercial property, at first glance it is clearly not as straightforward a proposition as residential property. For all but the most wealthy investors, a direct investment in a quality commercial property is very likely out of reach financially. This is where an unlisted property trust can be a good option. By pooling money with others, investors gain access to much more valuable, and potentially more profitable assets.

It is true that unlisted trusts, by their very nature, are illiquid, funds are tied up for a period of time, and exiting before the end of the trust requires an investor to find a buyer for his/her units, which can be difficult. In the case of Centuria’s unlisted funds, the initial term of the trust is 5 years, with the option of a further 2 years following a vote by investors. Locking funds up for up to 7 years is not necessarily prudent for all investors, but for SMSF trustees, a longer term time horizon can be perfectly consistent with their longer term investment horizon.

So for SMSF investors considering an investment in commercial property, and unlisted property trusts in particular, how should they go about evaluating their alternatives?

The bottom line is that as with any investment, in and outside of superannuation, there will always be a measure of risk. When it comes to unlisted commercial property trusts, the best way to mitigate these is to focus on the things you can control, like the quality of the underlying assets in the trust and the quality of the management. Needless to say, the two are inextricably linked, and the ability of a manager to choose a quality property and maximise performance over the life of the trust is crucial for performance.

So what exactly should investors be looking for?

When it comes to the structure of the trust itself, some of the important factors to consider are the terms of the trust, the gearing in the trust, the conditions surrounding early exit, fees and charges (including performance fees), and valuation and distribution strategies.

And from the manager? In our view, the most important thing to look for is transparency. You should be able to ask for and expect to receive full and frank communication about all aspects of your investment.  At Centuria, this means quarterly reports as well as face-to-face updates with investors, immediate communication of any issues and opportunities, and the option for investors to speak directly to senior management.

With confidence in the manager, investors can have confidence in their ability to choose property assets likely to perform over the life of the trust.