How economic trends could impact your portfolio in the mid-term
In this episode of The Smart Property Investment Show, IPA’s general manager of technical policy, Tony Greco, gives hi...
Not all asset classes are created equal, so choose wisely, writes Scott O’Neill.
Office, retail, industrial or speciality? Which is best for you to create the most reliable long-term passive income and capital growth?
There are many factors which inform the important decision of which asset class to choose. And, just as residential markets move in cycles, so too do commercial. However, some asset classes will always be riskier to invest in than others.
We rarely invest in speciality assets for instance. Childcare centres have the potential for long leases; however, for our investment criteria, they are too niche due to them not being easily lettable to multiple tenants, turning them into a potential liability.
Add politics to the mix, along with the strict regulations and their reliance on government subsidies to be profitable, childcare centres might be riskier than other commercial asset types as tenants can’t run them without external government interferences.
However, if you are certain you’d like to invest in a childcare centre, make sure you look at the occupancy rates for the centre, investigate any potential competitor centres to be built nearby, and review the strength of the childcare management. I also find the newer the better. You don’t want to purchase an old centre only to find that parents are choosing a more modern facility down the road.
Service stations are another example of an asset type we have avoided in the past. Classed as ‘special purpose’ because the property only has one use, there are many things you must consider before jumping into a fuel station asset. For example, in addition to the usual challenges that come with satisfying your due diligence on commercial real estate, service stations offer their own unique set of considerations, such as environmental protection and contamination issues, tanks and lines, the lease terms, equipment ownership, and maintenance and finance.
But even if the investment stacks up in 2021, what does this asset look like in a world of battery-powered cars? How would we re-purpose this highly specialised asset into something that’s appealing to other tenants given its location and its uniqueness? Also, what if another service station is built close to yours?
Immediately the viability of your service station investment might be compromised forever. This could mean you would be sitting on a multimillion-dollar commercial site without an income, (or a lease with a significantly reduced income). Not my cup of tea.
When it comes to commercial investing, it’s obviously not as easy as dividing asset classes into ‘good’ and ‘bad’ investments as there are always exceptions and sub-classes within asset types. For example, during the COVID-19 pandemic, office space and retail have taken a larger share of the hit due to people working from home and with the move to online shopping. However, during these times we have seen that some non-discretionary retail assets such as supermarkets, bottle shops, and pharmacies have a unique resilience and they are now in high demand.
What makes these great investments is that (being physically larger assets) there are simply fewer of them and they are almost always tied to long leases, but even more importantly, they are often surrounded and buoyed by other non-discretionary businesses such as butchers, bakeries, hairdressers and you guessed it, bottle shops.
Last year, a Dan Murphy’s on Mosman’s Military Road sold for $13.25 million. With 278 inquiries and what is believed to be record-breaking web traffic during the campaign, the highly sought after retail asset is brand-new, has a near full-term lease and is a reputable brand. Add the fact that it is one of only a few liquor shops on the lower north shore and you can see how this is an exceptional investment.
We have also seen suburban cafes and office spaces remain in high demand as people still prefer staying local to commuting to the CBD. Social distancing may be around for some time still and the new post-COVID world has less demand for public transport, less of an inclination for people to be in confined lifts and seen the concept of working in an airconditioned tower with thousands of others re-thought. Smaller office spaces, however, don’t have the same issues. Within the office asset class, small offices such as law firms or real estate agents are continuing to thrive.
The main message here is even through retail and office markets are overall weaker since COVID-19 hit, there are certain investments that are growing in value faster than we have ever witnessed. Mostly due to super-low interest rates and low supply. The types of retail which we like to purchase for our clients are doctors surgeries, dentists or physiotherapists, bottle shops, supermarkets, multi-tenanted and any big branded tenant who has not had any rent relief since the pandemic began. Things to look for are centres which already have a steady stream of goodwill established in the business and boast expensive fit-outs which wed the tenants to the property.
But the star of the show right now really has to go to industrial assets, particularly warehouses in capital city locations or other major population growth centres. With more brands moving online, the need for storage is growing. Although demand for this asset class is increasing as investors scramble for the few high-quality properties available on the market (and while others hold onto their assets), we are still sourcing special gems through our networks which boast high yields, as well as room for capital growth. Pandemic or not, we can safely say that when we look 10 years ahead that these asset types are as ‘good as gold’.
During 2020, Rethink Investing has been the most active in our company’s history in helping our clients purchase properties. Currently, we are seeing commercial net yields of over 7 per cent and interest rates lower than 3 per cent. This represents a 4 per cent gap between the net yield of the property and the interest rates. Historically we expect to see a 2 per cent margin between the two. What this means is right now there’s the opportunity of a lifetime to get the best cash flow returns you will ever see out of commercial property. This, in turn, should result in strong capital growth as the gap between these two metrics narrow.
Scott and Mina O’Neill are co-authors of Rethink Property Investing (Wiley $29.95) and founders of Rethink Investing, Australia’s number one buyer’s agency for commercial property investors. After retiring at the age of 28, they now live off the passive income generated by their personal $20 million property portfolio and have helped over 1,800 clients purchase around well over $1 billion in Australian real estate. Find out how to do the same at www.rethinkinvesting.com