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Commercial versus residential property: predictions and investment options

Both residential and commercial property segments have experienced a strong period of capital growth in the past six years, Luke Dixon, AMP Capital’s Head of Real Estate Research, says.



It’s a bit like a battle of the titans when it comes to assessing the commercial versus residential property markets.

On the one hand, capital growth of the residential real estate segment in many geographical areas has outpaced most other segments, but experts are now cautioning investors in some markets on valuations.

Meanwhile, the somewhat harder to access commercial property segment has a yield story that continues to play out in some areas thanks to strong demand driven by investors and tenants.

Both residential and commercial property segments have experienced a strong period of capital growth in the past six years, Luke Dixon, AMP Capital’s Head of Real Estate Research, says.

It’s important for self-managed super fund (SMSF) investors to understand the drivers behind both the residential and the commercial parts of the property market when making decisions about asset allocations for their fund, Dixon adds.

Driving forces


In commercial, investors have sought out income-generating assets like infrastructure and real estate that provide long-term, secure income, which is especially attractive to superannuation funds, Dixon notes.

Meanwhile, the residential part of the market has also been very strong, with average total returns of 11 per cent a year over the last five years across the five major capital city markets.

Looking forward, demand for space and the changing nature of tenancy could make yield a feature of the commercial segment, Dixon says.

“What we’ve seen as the economy has improved and moved away from mining-based services to financial services and technology is that rents have risen,” he explains.

On top of that, in cities like Sydney the supply of commercial properties has reduced, which has also supported rents.

“So it's become quite a balanced market [in commercial], driven by strong demand from investors and tenants,” Dixon says.

Residential property prices, meanwhile, are linked to the two key drivers – population growth and employment, both of which have remained strong.

Two-speed residential


“We've got two economies in Australia. There are the resources states like Western Australia and Queensland, and the service states of NSW and Victoria, where economic growth has been much stronger in recent years,” Dixon says.

“While we've seen a cooling in values in some inner city markets, particularly in units, the fundamentals point to stable, but slower growth in the near term. Across units and housing, markets are still strong. We're just not seeing the same surge in growth we've seen before,” says Anthony Millet CEO of innovative real estate investment business BRICKX.

“Sydney's still very strong, but people are being more realistic with price expectations. We're seeing less cooling in Melbourne in house price growth because it’s relatively more affordable than Sydney,” he says.

While residential real estate has been difficult to access other than through purchasing the entire asset with or without a mortgage, BRICKX is changing the way investment takes place in this $7-trillion market.

BRICKX is a platform that brings residential assets in blue-chip suburbs online and fractionalises them into 10,000 units – or "Bricks" – providing a way for Australians to be able to invest in residential real estate, Millet explains.

BRICKX has created a platform for Brick Holders to buy and sell Bricks at a time of their choosing, offering an alternative to what is often an illiquid real estate market.  Over 150,000 Bricks have been transacted since launch, and with over 7,000 members, BRICKX has had particularly strong engagement with SMSF investors who are leveraging their ability to diversify across 14 different properties in Sydney, Melbourne, and Adelaide.

Commercial strength  


As to whether commercial or residential markets are more attractive at the moment overall, Dixon believes commercial real estate has the potential to be a much stronger performer.

“Commercial real estate offers investors better income and capital returns over the long term. The reason for that is it's much more evenly balanced between income and capital return. Over the last 20 years, commercial properties have delivered an average annual total return of 10%,” he notes.

The residential sector has returned 8% per annum over the same period.

“Commercial real estate ticks all the boxes for investors looking for long-term income generating assets. It's had strong capital growth as well,” Dixon explains.

It’s typically been difficult for SMSF investors to access commercial property investments given their high cost and the complexity of investing in property through SMSFs and the time and skill it takes to manage these assets.

Rather than taking a direct investment, managed funds offer another option.

“By investing with the right fund manager - one that takes an integrated approach to asset management, can enhance the assets to attract higher returns and reduce the risk of the asset going un-tenanted, investors can ultimately supercharge their returns.   Average residential management costs tend to be higher than commercial properties, and are prone to issues relating to poor management and income gaps through the cycle,” says Dixon.

Future cooling


AMP Capital’s house view is for a cooling of the residential property market looking forward.

“We are seeing historically peaked pricing, but we're also seeing a lot of supply coming through,” says Dixon, who says interest rates are the determining factor for the residential market.

Should interest rates rise significantly, while household debt levels remain high, then, housing prices would come under pressure.

From a commercial perspective, very low supply in Melbourne and Sydney should support rents in the short to medium term for the office markets.

“Industrial property is benefitting from increased demand for e-commerce and online retail services. We’re forecasting demand for more than one million square metres space on the back of the arrival of Amazon and other e-commerce in the market over the next two to three years,” Dixon says.

“Retail is stable, but returns will be under pressure from e-commerce and weaker wage conditions in the medium term,” he adds.

For SMSF trustees, it’s worth gaining a good appreciation of both residential and commercial assets when making portfolio allocation decisions to ensure the assets in the fund are aligned to members’ needs.
 
Funds related to this article: Wholesale Australian Property Fund

An income focused fund providing exposure to a diversified commercial property portfolio of high quality Australian office, retail and industrial properties often only available to institutional investors.

The Fund’s key aim is to provide investors with reliable income and long term capital growth.

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