As the property markets of Sydney and Melbourne continue to face declines, experts are encouraging investors to diversify their portfolios by exploring other markets. Rethink Investing’s Scott O’Neill lays out a simple strategy to help investors thrive in today’s changing market.
Since Sydney and Melbourne started to show signs of decline around 2017 following an unprecedented property boom, residential property investors have been keen to find strategies that will help them ride out the waves of fluctuating markets, according to Mr O’Neill.
One of the investment strategies that emerged during the time was diversification, either by looking into properties in other markets or investing in other asset classes.
“Diversification comes to play. When the market was slowing down, it gave people the idea that the guaranteed growth for the residential wasn’t going to be there forever. Naturally, you look for alternatives.”
Some investors have looked into accessing their equity in order to continue the expansion of their portfolio despite the softening of property markets and the tightening of the credit environment.
“The yields people were buying into for so long into Sydney and Melbourne were at record lows, so if they’ve made equity, even if it’s coming down, they’re going to naturally look to use that equity to create more cash flow.
“It’s almost a default move – diversify into a market with better cash flow,” Mr O’Neill highlighted.
Among the options for property investors looking to diversify at the moment is investing in commercial properties, according to Mr O’Neill.
Commercial properties take its appeal from the scarcity of supply and, ultimately, its ability to provide positive cash flow. Even commercial properties below the million-dollar mark has great potential for wealth-creation, the buyer’s agent said.
“If there's good tenancy, a good quality property doesn't last more than 30 days on the market. Compare that to most residential markets at the moment, it's twice as fast.”
The ‘sub-million dollar’ commercial properties can range from large warehouses to multi-use facilities where the investor can typically work with three- to five-year leases.
Mr O’Neill explained: “We personally only buy stuff with 7 per cent net returns or better. The tenant pays all the outgoing. The risers are built into the lease of around about three to four per cent per annum. In a way, that’s going to be giving you equity of three to four per cent growth on your property each year, which is lovely at the moment.”
“If you can make good cash flow and some growth just through rent rises, you’re looking pretty good. That’s why a lot of people are turning to it.”
“You can never be certain about the residential side of property investment, but diversifying throughout your journey is a good option for cash flow.”
Most people with substantial residential property portfolio are looking into commercial property investment to improve their cash flow, which would then support the expenses related to holding their existing properties long enough to see the market recover significantly.
According to the buyer’s agent: “It is mostly people with portfolios, with an income behind them. They just want to create passive income from this, which is quite large, and they, of course, understand the risks and the rewards.”
In order to succeed in wealth-creation through this alternative asset class, Mr O’Neill advised investors to have a clear business model.
At the end of the day – not too different from residential property investment – success in commercial property investment is about ensuring that the investment is maximised through returns, all without having to overcapitalise.
“If you go buy a $300,000 property, you're going to have to put $90,000 down plus the stamp duty. Still a six-figure property but quite a cheap one. The people that can afford that and understand business see the opportunity.”
“If you buy a few of those and half pay them off, that’s an incredible passive income you’ve got. You can quickly create a $50,000 passive income, which, to a lot of people, is a great headstart for retirement.”
Investors are also advised to study the risk involved in commercial property investment.
For one, buying the wrong asset for too high a price can ultimately derail the wealth-creation process as it could affect the equity produced by the property.
Mr O’Neill said: “Things can go wrong if you buy the wrong asset. For example, if the rent is too high per square metre and you get suckered into the sale, that could hurt because you’re going to have to release it at a lower price. You’re going to lose equity.”
Apart from educating themselves and doing due diligence, investors are also advised to engage property professionals, where appropriate, in order to make the best decisions, particularly if they are only transitioning from residential property investment to commercial property investment for the first time.
Much as there are similarities to both asset classes, there are different factors and policies that could influence their growth and overall wealth-creation potential over time.
“Once you understand the triggers, a buyer's agent will help you through all that. It takes a lot of that risk out and I think people are more comfortable when someone helps them get into it.”
“There’s always a lot of opportunity to create equity in the market, even right now,” Mr O’Neill concluded.