More small investors using SMSFs to buy commercial property.

August 5, 2017

Small investors are becoming increasingly aware of the benefits of using their self-managed super funds (SMSF) and trusts to buy commercial property, encouraged by the higher income yields and lower level of risk than some other asset classes.

Commercial property can offer a net investment yield, after fees, of between 6 and 6.5 per cent – as against less than 2 per cent for residential property – in most CBD markets, says leading Australian property group, Charter Hall.

“Our investment philosophy is to invest in high-quality, institutional-grade commercial property in strategic locations, leased to high-quality tenant covenants on long-term leases,” said Steven Bennett, head of direct at Charter Hall. “This approach to investment allows us to manage our portfolio through the cycles providing investors lower volatility than other investment classes.

“Commercial property is now firmly on the radar of investors who want to use their SMSFs and trusts for investment. A lot of retirees and people transitioning to retirement are chasing secure income yields and, with term deposits and bank rates so low, commercial property is very appealing.”

Australian Tax Office figures show that SMSF investment in commercial property has grown nearly 47 per cent in just under five years to March 2017, from $53.2 billion in 2012 to $78.2 billion. As a percentage of total SMSF assets, however, it’s slipped from 12.9 per cent in June 2012 to 11.6 per cent at March 2017.

The SMSF Association has been watching these trends closely. “Direct investment in commercial property by SMSF trustees has been a significant feature of the SMSF sector,” said head of policy Jordan George.

“It’s especially been a core investment for SMSF trustees who have a small or professional business where they own the business premises through their SMSF.”

Often the premises are the most significant asset in a business and owning it via an SMSF meant it could be held in a concessional tax environment and used to fund retirement later in life.

“But SMSF trustees looking at this strategy should always seek specialist advice to ensure that the commercial property investment meets the required definition of being ‘business real property’ and other technical aspects of the superannuation law,” said Mr George.

The issue of how commercial property can be an important investment for SMSFs and trust funds will be one of the themes at the upcoming Symposium17 hosted by Commercial Real Estate on August 30, at which Mr Bennett and Peter Hogan, from the SMSF Association, will be speaking.

The keynote speaker at the symposium will be former prime minister The Honourable John Howard, OM, AC, who among other things will be talking about foreign investment, Asian markets and the impact on the commercial property industry.

Mr George said that commercial property could offer a stable income for SMSFs, with lower capital risk than other asset classes, and also promise attractive capital gains at about 3 to 4 per cent. That could take annual total returns above 10 per cent which, in the pension phase, could come tax-free.

“However, like any asset class, individual commercial property investments should be evaluated on their merits and not assumed to perform the same as the asset class in general,” he said.

In addition, he said SMSF trustees were increasingly investing in unlisted commercial property syndicates and unitised office property funds.

“It’s part of an overall trend that is seeing them diversify their portfolios away from blue-chip, fully franked Australian shares and cash and term deposits, and one we would expect them continue pursuing,” he said. “We always encourage trustees to seek specialist advice when re-evaluating their portfolio mix.”

Mr Bennett recommended investors should also look at how returns were delivered to them. “For example, we focus on long-term leases, anywhere between five to 15 years and in some cases up to 20 years. This provides a certainty of income throughout the fund’s life and allows us to manage re-leasing risk.

SMSF trustees are increasingly investing in unlisted commercial property syndicates.

“However, a tenant on a three-year, shorter-term lease will give you a different income curve to a tenant on a 10-year lease, but we think it is higher risk because it exposes the asset to market pressures and potentially not producing income every three years.”

The Charter Hall Group, with a total managed property portfolio of more than $19 billion, owns and manages 314 commercial properties around Australia, including office buildings, supermarket-anchored retail centres, and industrial assets.

“We have high-quality tenants on long-term leases who are leaders in their sector,” Mr Bennett said. “Across our entire group portfolio, 70 per cent of our tenants are ASX 200 companies and 20 per cent are government tenants. The weighted average lease expiry (WALE) is around 10 years so we know we have high-quality tenants on long-term leases which provides secure long-term incomes to our investors.”

Accordingly, one of the most important things for SMSF investors to check was who would actually be managing their investments. Mr Bennett said it was important to make sure they were in the hands of a credible manager with a good track record.

Mr Jordan said that happily, trustees were increasingly seeking specialist advice on commercial property investment, appreciating they needed to be aware of issues such as the management’s track record, as well as the quality of the asset, whether CBD or suburban, the WALE, and the expected yield.

He said that the commercial property sector had also been largely unaffected by the introduction of the $1.6 million assets cap on SMSFs in the pension phase that took effect on July 1.

“This new rule means funds in the pension phase must transfer back assets exceeding $1.6 million to an accumulation fund and pay a 15 per cent tax on all earnings,” he said. “However, funds are not required to sell assets as they can be apportioned between the taxable and tax-free part of the SMSF.

“Also, funds affected by the $1.6 million transfer balance cap can access transitional CGT [capital gains tax] relief which allows them to reset the property or unit’s cost base to its market value on 30 June 2017, washing out any accumulated capital gains. For trustees in a listed or unlisted property vehicle, it’s just a case of transferring units from a pension to accumulation fund.”

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