Wednesday, October 04, 2017

Beyond The Rear View Mirror

Is residential property the right investment for you? Tom Threlfall, Investment Specialist at Perpetual Private takes a look at some of the pros and cons of property and discusses an alternative. “Buy land, they’re not making it anymore.”Mark Twain What would a financial adviser say if you walked into their office with plans to invest in residential property? Tom Threlfall, an Investment Specialist from Perpetual Private, shares his views in this interview.

Q: Let’s start off with the big one, what is your view of residential property in Australia, at the moment?

A: I think the most important thing when looking at real estate, whether it is residential or any other asset class, is understanding it in your portfolio context. When considering residential property we often think that it is a great high capital growth asset class, when actually the longer term assumptions of the capital growth in property are Consumer Price Index (CPI currently 2.1%) plus one or two percent. Also the yields are not exactly spectacular after taking out the costs of land tax and other various costs. The ABS estimates annual outgoings are around 2%, excluding any vacancy. Therefore, when we look at it from a portfolio perspective using our return assumptions and not the reality of what has happened – we weigh these up and consider them against other asset class opportunities.

Q: So it’s really important for people to think of residential property as part of a portfolio, not an asset all off by itself?
A: That’s absolutely right. I understand why it’s an important one – we live in our homes, it’s the asset class that people feel most familiar with and people feel like they have a good grasp on property valuation, whereas other asset classes they may have no experience with. There is however also risks associated with real estate. One of the most obvious is illiquidity. It’s quite hard to sell a portion of a house; unfortunately, you can’t sell your bedroom if you need to raise money for a specific reason. In a portfolio context it’s important to understand the risks as well as the benefits when considering each asset class (and in our example the majority of clients realise a ‘cap’ on illiquid investments such as residential is important).

Q: If a client came to you and said “I’ve got a chunk of capital I want to deploy, I’m thinking of residential property” What’s your answer to that question right now?
A: We would step through the pros and cons and talk about what their assumptions are about why they are doing it and what gap they are trying to fill in their portfolio. In this context, we would ask “Is there a better way to remain more diversified?” One of the key things we look at is the risk and return assumptions of each asset class, but in addition to this, we also look at diversifying across various asset classes. The reason we do this is because remaining too concentrated across any one asset class can have portfolio affects that significantly outweigh any of the benefits.

Q: Are there other asset classes or types that you would suggest to clients that have a similar risk and return profile to residential property?
A: Another asset class that is similar to real estate is infrastructure. Infrastructure has all of the same assumptions as property but the difference is that the earnings may be well supported.

Q: Tell us a bit more about infrastructure, as I think people are starting to get a grasp of that as an asset class?
A: One of the attractions to infrastructure that we like at Perpetual Private is that earnings are well underpinned. What I mean by that is if you’re creating a toll road, a lot of commuters use roads and therefore there is a concrete example and history of understanding how that earnings work through an economic cycle and I’m sure as you’ve noticed they have pricing power (I still remember when the harbour bridge was $0.20). It all depends on price paid for assets, but infrastructure can offer an alternative to real estate and often has stronger cash earnings.

PUTTING IT ALL IN CONTEXT

Eliminate emotion
People feel more comfortable with residential property than many other asset classes. It is a tangible asset that people live in and are familiar with. And residential property has been a strong performer – particularly on Australia’s eastern seaboard. Who wants to miss out?

There’s investment risk in this sort of thinking:
• Overestimating your understanding of an asset class
• Assuming past performance will continue
• Investing for fear of missing out. Tom’s point isn’t that the Australian residential market should be avoided – rather that a decision to invest should be free from emotion. “It’s tangible, it’s solid, it’s beautiful. It’s artistic, from my standpoint, and I just love it.” Donald Trump

TAKE A PORTFOLIO VIEW

Tom’s advice is to think of residential property in the context of your broader investment portfolio. Like any asset class, being too concentrated in property may bring a level of risk that significantly outweighs the return.

Ask yourself – what purpose will an investment in residential property play in your portfolio? Is it to diversify, to secure ongoing income or is it purely for asset growth?

Despite the current perception that residential property is a high growth asset class, the longer term assumptions are Consumer Price Index plus one or two percent (which in today’s terms equates to 3-4%). It’s tempting to look in the rear-view mirror as the basis for future asset growth – but it’s risky.

OPEN TO ALTERNATIVES

What are the alternatives to residential property? Tom cites infrastructure as an asset class worth considering, particularly in light of the infrastructure spending signalled in the Turnbull government’s recent budget. On the positive side, investment earnings may be supported by government and there’s a framework for understanding how returns will work with assets like toll roads. But there’s also risk - interest rate rises will impact the infrastructure market as they would property.

The key is to objectively assess alternatives like infrastructure – not in isolation but as part of your structured portfolio. Focus on the balance between risk and return and be clear on the reason for the asset class to be in your portfolio.

If you’d like to have a conversation about creating a diversified portfolio to support your goals, please contact Steven Macarounas at editor@theprivatepractice.com.au, for an introduction to an endorsed specialist adviser.

Perpetual Private advice and services are provided by Perpetual Trustee Company Limited (PTCo), ABN 42 000 001 007, AFSL 236643. This article has been prepared by PTCo and may contain information contributed by third parties. It contains general information only and is not intended to provide advice or take into account personal objectives, financial situation or needs. The information is believed to be accurate at the time of compilation and is provided by PTCo in good faith. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information.

 

Investment Specialist at Perpetual Private

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