There are a number of ways to invest in real estate in Australia. We have highlighted 3 distinct approaches to invest in real estate that will meet most individuals risk and reward criteria. These approaches are direct real estate, listed REIT and REIT ETF.
While investment return is important and key criteria in evaluating real estate investments. There are also a group of factors investors should take into consideration before making the final decision. We have highlighted the strength and weakness of these factors in the first two approaches.
Direct Real Estate Investments
Direct investment means the investor owns and take direct control in selecting, buying, selling and managing the property. Investors does not give up the money for a specialist to manage it. Rather they are themselves responsible for the day to day management even if there is a managed property manager.
risk: primary risk in direct property investments are asset specific and real estate market exposure. Asset risk include risk of tenants not paying rent on time, damages to property outside insurance and developments that could affect negatively on investors property.
volatility: The price is more stable compared to listed investments. Since direct assets are held at book value and not mark to market. Indicative changes in prices are based on transactions in comparable assets in the same neighborhood or suburb which can be infrequent. While market can go up and down over the investment horizon. The only price matters is price when the asset is sold.
cost: aside from the unavoidable costs such as interest, stamp duty and council rates. Investors have a higher degree of control on additional expenses such selecting property management companies, how the budget is managed and when to undertake capital expenditure.
liquidity: It is the most illiquid option out of all 3. Liquidity is only achieved when the property is sold and selling period is considerably long.
flexibility: Contrast to liquidity, direct asset investment is the most flexible as the investor is responsible for all stages of the investment process.
tax: While we always prefer positive geared investments, individuals have the opportunity to utilize negative gearing. If the investor occupies the property, there are significant tax savings when the investment is realized.
Listed REIT is an indirect investment in real estate. Example of REIT include Westfield and Dexus. Similar to investing in shares, it is effectively paying money for a manager to manage real estate assets. This can range from commercial real estate assets to real estate securities. Individual does not have control on the day to day management or asset allocation in the portfolio. Rather rely on the manager of the real estate investment trust’s expertise.
Advantage of REIT is that it provides exposure to a diverse portfolio of real estate assets. Contrast to direct real estate investment where it is very difficult for individuals to achieve diversification. Usually the portfolio is heavily concentrated where investors only have 1 or 2 assets.
risk: Unlike direct real estate assets. Listed REIT are exposed to equity market risk. This include changes in overall market sentiments. Changes in interest rates are reflected in asset pricing almost immediately. Daily value of the portfolio of investment is based on what everyone think it is worth rather than comparable transactions or valuations.
volatility: downside of investing listed REITs is that investors are exposed to day to day changes in the investment. Paradoxically the value of the underlying assets are more stable than the daily trading price. There could be significant periods when the price deviate from value.
cost: Advantage of REIT is its low cost. Entering and existing positions reflect the cost of brokerage rather than stamp duty and other transaction costs. Management costs benefit from economies of scale which are typically under 1% of asset under management.
liquidity: REIT is as liquid as you can get for investing in real estate. REITs are traded on the Australian Stock Exchange. Investors can buy and sell REIT securities daily.
flexibility: As it is a indirect investment. Investors do not have as much input in directing the day to day investment process. Real estate in the trust is managed by a team hired by the board of directors. Investors uses their units vote in selecting the board of directors.
tax: Typical distributions from REITs are tax deferred. Capital gains are calculated similarly with investment properties.
REIT is amalgamation of listed REIT approach to property investment. The investment profile of REIT ETFs are similar to REITs with the primary difference being that it is the most diversified of all investment options. REIT ETF owns a portfolio REITs.
This is the most passive investment option for investors looking to add real estate exposure. As the ETF owns a portfolio of REITs diversified across all sectors. Investors gain market returns and take on market risk. Total returns will reflect real estate asset performance across the sector. While returns can be lower than individual REITs, the offset is that it is accessible for those that are not familiar with investment . It is not picking stocks but picking the sector.
REIT ETFs allow investors broad real estate exposure without the hands on management of the portfolio or assets. For those that are interested, can read more from our analysis of REIT ETF on ASX.