Understanding Asset Classes: Property
Property has long been a favoured investment asset class for Australians generally as well as within a SMSF structure.
However, the nature of the underlying investment varies between the two investor types, with SMSFs holding a higher proportion of non-residential property than residential and retail investors tending to invest in residential property outside a SMSF. This does not say that SMSFs do not or cannot hold residential property as an investment class.
Investments in property can be subject to ‘property cycles’, which are driven by expectations around property values. If there is a predominate view that property values will rise; prices tend to follow. As the term suggests, cycles do move from a low, through a peak and descend, so the reverse applies when the view on property values switches; prices can fall.
Property cycles may vary in terms of the nature of the underlying property type and the drivers and duration of the cycle may be different for each property type. A strong economy can drive the demand to commercial property, such as offices and warehouses, while a growing population can drive demand for residential.
To achieve diversification across the property component of an investment portfolio, the SMSF should hold a range of property types to take advantage of different cycles.
If the preference is to hold the properties directly, it may be difficult to achieve a broad enough spread of property types, as the cost associated with buying one, let alone a number of properties could be prohibitive.
Listed Property – Real Estate Investment Trusts (REITs or A-REITs in Australia)
There are a number of sectors available, including:
- Office – holding one or more office buildings usually in capital cities or major regional centres. Income is derived from business paying rents to accommodate their workforce.
- Retail – shopping centres or shopping malls where income is derived from rents paid by tenants such as shop and business owners.
- Industrial – usually warehouses that are used by businesses to store and/or transport goods.
- Diversified – a combination of the above, or
- Specialised – where the investment relates to a specialised area such as retirement facilities or bulk storage.
The trust structure by used REITs provides a different way of paying income. Unlike equity or share investments, tax is not paid at the entity (trust) level and income after costs is passed through to the investor (SMSF) with any tax considerations worked out at tax time.
SMSFs can hold property directly, however, the capital required to buy a number may see the SMSF focus on small commercial properties, such as the business premises used by small business – office, factory or warehouse. The businesses that use the facilities can be operated by members of the SMSF. The alternative may be to own one or more residential investment properties.
Running a direct property portfolio can introduce an added level of administration that requires a more ‘hand-on’ approach, with trustees collecting rents, paying bills or finding new tenants when needed.
Not having sufficient funds to invest directly in a range of different property asset class types could see a SMSF:
- invest in one only, opening it up to the cyclical movements of that type alone
- invest a disproportionally high amount into one or a few assets due to the cost associated with buying property.
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