Pete Wargent blogspot
Co-founder & CEO of AllenWargent property advisory, offices in Brisbane (Riverside) & Sydney (Martin Place) - clients include hedge funds, resi funds, & private investors.
4 x finance/investment author - 'Get a Financial Grip: a simple plan for financial freedom’ (2012) rated Top 10 finance books by Money Magazine & Dymocks.
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Wednesday, 7 November 2012
3 prevailing myths about Property Trusts
Straight to the point today. Property Trusts are an inferior investment. And I’ll explain why.
What are Property Trusts?
We used to call them Listed Property Trusts (LPTs). As is our way, we wanted to sound a little more American, so now they are known as Australian Real Estate Investment Trusts (A-REITs).
A-REITs allow investors to purchase an interest in a diversified and professionally managed portfolio of real estate, much as in the same way as you’d purchase a share in a company or a unit in a managed fund.
The real estate portfolio might include commercial, industrial and retail assets.
Why would you trade Property Trusts?
A-REITs can provide you exposure to assets that otherwise would not otherwise be readily accessible.
You can gain the benefit of any increase in value in the underlying asset and regular rental income generated from the properties owned.
So property trusts effectively provide liquidity to an illiquid asset class.
There are 3 common myths about Property Trusts:
Myth 1 – Property Trusts aren’t really property
You might sometimes hear punters argue that ‘Property Trusts do not represent real property because they are listed.’
While the performance of a Property Trust may be a little volatile in the short term because it is listed, eventually the unit price must eventually represent underlying performance of the property owned.
Sure, due to a listing on the securities exchange, over the short term price and value may differ as prevailing sentiment changes.
But over time stock exchanges are weighing machines, not voting machines.
Myth 2 – Property Trusts offer great growth
Afraid not. The numbers are there in black and white. Over a period of decades, growth on property trusts has easily underperformed the industrials index.
The source of the myth is probably that punters have seen the price of their own house go up and therefore assume that property outperforms shares.
Without anything worthwhile to benchmark against, the punter draws an incorrect conclusion.
Property Trusts distribute their income. With no retained earnings, what must a trust do to buy a new property or to refurbish one?
It only has two options – raising debt or equity. It can borrow more funds against its existing assets or it can raise capital, which dilutes your holding and kills capital growth.
What you have to remember is that if you could make more money simply owning commercial property than you can through business…then why would anyone ever go into business?
Myth 3 – Property Trusts pay great income
Afraid the numbers let the case for Property Trusts down again, but in this case at least, it’s easy to see where the myth comes from.
Property Trusts distribute their income and thus their yield percentage is high – higher than that of the wider share index for decades now.
The trouble is a high yield is not the same thing as a high income. It’s an insidious trap.
With poor capital growth, the actual dollar payout over time massively underperforms the industrials index.
Does that mean property is a bad investment?
Now we get to the crux. Industrial shares outperform Property Trusts, and therefore property is a bad investment, right?
Well, I’ll give you an independent view on that, for I’m not a property investor and nor am I a share investor. I’m just an investor.
There are two cases in which I would steer clear of residential property.
Firstly, if it was the case that I could only buy a property index instead of individual properties, I wouldn’t bother.
Fortunately, that’s not true – investors can choose outperforming properties and they can use a range of other tools (land-banking, renovation, subdivision, development approvals…) to ensure that they outperform the averages.
Share investors can choose an outperforming sector too – the industrials index.
Residential property is inefficient, so skilled investors can invest counter-cyclically and identify outperforming property types and locations.
Even this argument still misses the key point.
The second case where I’d steer clear of residential property would be if I could use no leverage (or, theoretically, in the unlikely event that I come to be the owner of ten million big ones, sitting lazily in cash).
Property Trusts may themselves use leverage, but as an average investor the amount of leverage that can be personally taken on will be capped.
Here’s the coup de grâce: the single biggest reason for average investors to be in residential property is because it allows them to own and manage for the long term a portfolio that is measured in millions, instead of one which is measured in thousands.
I had to try really darned hard not to finish this article with any of that most unwelcome triumvirate of concluding idioms: