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For most investors seeking exposure to investment-grade Australian commercial property managed by an experienced and proven manager the choice is often between two options.
One can invest in ASX-listed Australian Real Estate Investment Trusts (AREITs) or direct property funds, also known as unlisted property funds.
Both investments feature a general focus on high levels of income for the investor, but what are the differences, and how to choose?
The first difference is the minimum investment amount.
For AREITs it is the minimum parcel of shares that can be purchased on the stock exchange, say around $2,000 for an economic parcel, once you take into account brokerage costs. Unlisted property trusts generally have a minimum investment of $20,000.
The value of unit in an AREIT fluctuates on a daily basis on the share market, affected not only by the performance and value of the individual trust but also by broader market sentiment and movements
Unlisted property trusts, on the other hand, utilise independent valuations of the underlying property portfolio to derive the entry and exit price of the funds’ units, regardless of whether their units are valued on a daily, monthly or quarterly basis.
The pricing is therefore not impacted by movements in the equities markets or investor sentiment.
Due to the periodic valuations, unit values generally have lower levels of volatility and are not subject to the ups and downs of the stock market. You will often find it said direct property funds have a ‘low correlation’ to the major asset classes of equities and bonds.
Put another way, low correlation simply means that prices of direct or unlisted property funds move independently of the external factors that affect the listed share and bond markets.
Direct funds usually have quarterly or monthly income distributions whereas AREITs generally have six-monthly payments. Many retirees greatly appreciate more frequent cash flows and we increasingly find monthly payments are an attraction for investors.
The other side of the ledger for direct property funds is liquidity, or more accurately, lack of liquidity. Unlisted funds are designed to be held for a term, generally around five years. Funds for investing in a direct or unlisted fund should come from one’s ‘non-cash bucket’.
Some unlisted property funds have regular so-called ‘liquidity events’ or other redemption opportunities. This usually involves a small amount of funds being made available to investors who have an urgent need for cash. These events may happen every 6, 12 or 24 months, but they are not a means for investors to realize a large percentage of their holding.
Of course, the flip side to lack of liquidity is you don’t have the often arduous task of selecting a new, safe and attractive investment. I don’t like the term ‘set and forget’, but in some ways it is what you can do if you choose a good direct or unlisted property fund.
AREITs are listed on the ASX which makes them highly liquid. You can simply call your broker or use an online broker and your position can be liquidated in a moment. This provides portfolio flexibility to adjust your holdings and re-weight an investment portfolio at a time of the investor’s choosing.
The downside of being listed is volatility.
The market price of units can be above or below net asset valuation at any time.
When the market is up, AREITs may trade above net asset valuation. When the market is down, they can trade below valuation. This characteristic of course may not necessarily be seen as a negative: units trading below valuation arguably present a buying opportunity; units trading above valuation arguably present an opportunity to sell above fair value.
As a rule of thumb many advisers will suggest splitting your investment-grade property holdings between direct/unlisted property funds and AREITs.
If liquidity is a critical issue it makes sense to focus on AREITs. Conversely, if low volatility is a priority, unlisted property funds should form the major holding. Both offer strong levels of ongoing distributions.
The final issue of course is how much investment-grade property to hold.
Major super funds, the Future Fund and other major institutions generally hold between 5 per cent and 15 per cent of their portfolio in investment-grade commercial property. It’s a benchmark that is worth serious consideration, depending on your own position and the views of your adviser. Charter Hall currently has four major direct or unlisted property funds open to investors, with distributions currently ranging from 5.8% p.a. (Direct Office Fund) to 6.9% p.a. (PFA Fund) PLUS capital growth, making projected total returns of between 9% and 10% p.a. over the term of the fund.