Property investment returns are a combination of the rent (yield) and capital gain. In the past we were used to getting about a 10% return plus another 3% or so in capital gains.
Total return 10% Income + 3% capital gain = 13%
Income
Rental income since the credit crunch is likely to be a little less, due to less tenant demand, and also due to the reduction in depreciation that can now be claimed.
Rental yields on commercial property were typically 8% to 12% depending on location, the type of tenant, length of lease and many other factors,
For example Westpac bank on a 20 year lease might yield 8%. A small business on a 2 year lease in a rural town might be paying 12%. However many owners would prefer Westpac as a tenant for obvious reasons.
Since the credit crunch this yield range is likely to be reduced down a little to 7% to 11%.
Capital Gain
The global credit crunch has reduced tenant demand, and property investors are now less likely to borrow a lot of money to buy property. Less tenant and less buyer demand translates into weaker prices and a less likelihood of capital gains in the near future.
Future Total returns
Overall there will be less demand, so capital gains may not eventuate in the property market at all for several years.
If capital gain is going to be absent, then investors would be wise to focus on yield.
The typical yield on a residential rental property is around 3% to 5% pa.
The typical yield of commercial property is around 7% to 11% pa.
Diversification
Diversification is essential. If you diversity across bonds, property and shares on and offshore, you will never go far wrong.
The recent earthquake in Christchurch is a sad example. Imagine if you had all your money tied up in say 3 commercial properties in Christchurch. One might be badly damaged, one slightly dammed, and one OK.
You would most probably not be able to collect rent on the badly damaged building, and even with the best insurance policy, you would be out of pocket by up to 33% in lost rent. In addition you would possibly miss out on 10% to 20% in capital gain potential over quite a few years.
Diversification & NZ Risks
If you have all your money tied up in NZ, you are at risk because you are fully exposed to the NZ economy. It is very narrow and could easily be de-railed if we import a major “nasty” such as foot & mouth disease.
Diversification & Liquidity risk
Everyone needs liquidity or access to cash as emergencies do arise. Property is illiquid in that you usually cannot get cash out of it until you sell it, which can take several months or even longer.
Bonds and shares are usually liquid which helps. However we recommend everyone also holds some cash handy for emergencies.
Diversification & Tenant risk
Demand is lower from tenants – just look around locally and count the number of vacant commercial properties – the number is surprisingly high.
But beware, even big name tenants move on. I remember seeing a big building touted widely with the IRD as tenant. Six years later the IRD’s lease expired and they moved to bigger more modern premises.
Six years can come around quickly and an empty commercial building has a very low resale value.
If the owner/investor has borrowings, then an empty building is an even bigger risk and headache – who is going to pay the mortgage?
How much property do you have already?
Many Kiwis have already have a lot of property by owning a nice home and sometimes a rental and beach house as well. If you are a typical Kiwi, probably 50% to 80% of your total assets are tied up in property already.
All property values are affected by the NZ economy & events one way or other, so if you are heavily into NZ property, even if it is in different towns and different types, you may not be as diversified as you think.
Morningstar Research recommend that most NZ investors who own a decent home or more should not put more than 10% of their money into property investments.
The Best way
The best way to invest in commercial property in NZ is to buy shares in the well known listed property trusts (LPT’s) via the NZ share market.
By investing across the following four listed property companies (LPT’s), you will be widely diversified across the four main property types, and across dozens of buildings in each fund.
You can invest as little as $1000 into each fund, but $5,000 each or more would be more realistic and efficient.
ING Healthcare Property Trust – owns hospitals and healthcare centres.
Kiwi Income Property Trust - mainly owns shopping malls plus some office buildings.
Property for Industry – owns factories and warehouses.
AMP Office Trust – owns office buildings.
The trusts pay a dividend (the rent) of about 7% to 11% pa. , and are listed on the NZ share market so they can be sold at any time (liquid).
These funds are all traded daily on the NZ share market so are easy to buy or sell, and all are well diversified.
These are four well known companies, but note this is not a stock picking or forecasting method – simply diversifying across the property market place since no one can pick the right property stocks year in year out.
Global Property
For global property diversification, a small allocation to the DFA Global Real Estate fund fits in well - spread across about 240 listed property trusts (LPT’s) around the world.
Warning – Avoid Property Syndicates
A few of these are still around and they are can look good (are cleverly marketed). You should always remember to check :
“Who is promoting this to me and how are they getting paid?”
All too often they are getting commission if you invest. It may be that selling you the investment is good for them, but it may not be the best for you.
They often look good, with one or two big name tenants, but in fact are nearly always lacking in diversification. See the notes above about the IRD moving on when their lease expired.
Syndicates are not usually liquid, and you can only get out if you can sell your investment to someone else.
Syndicates can have high front end costs, for advertising, legal fees, commission to the sales people, and so on.
We have seen costs as high as 9% over and above the purchase price, and of course you will make no capital gain until the property has risen in value more than the front end costs. In a low capital gain environment, this could be many years away.
A lot of money has been lost in syndicates in NZ over the past decade.
Generally speaking syndicates only suit small groups of experienced investors who can work closely together.
Most syndicates fail our 7 point checklist
The 7 Point Checklist to Use Before Investing in Property
- Diversify across the four main property sectors
- If you own substantial property already, do not put more than 10% of your total assets into investment property
- Focus on yield - recognise that capital gains might be muted or even absent for several years
- Do not try and pick the “right” fund – stock picking is a futile exercise
- Do not try and forecast which property sector will out-perform over the next few years – forecasting is a futile exercise
- Remember that property is illiquid and access to cash can take months or longer
- Avoid syndicates unless you are a very experienced investor
