Investment properties: Great market outlook but check potential pitfalls

By Steve O'Malley

Friday 22nd February 2002

INVEST WHERE YOU SHOP:
Retail still leads the pack and strong retail sales figures will help increase rents

It's hard to think of a time in the past 15 years when local property prospects have been stronger.

Look at the basics. First, the economy. Unlike late last year, it doesn't look as if the economy will fall into a hole over the next 12 months.

It will slow down for sure but we're not looking at a recession. Moreover, the strong turnaround in migration looks like providing a significant fillip to the economy over the short to medium term.

Second, supply-demand balances across the board are strongly positive.

Both Auckland and Wellington CBD office markets are strengthening, with vacancies declining and rent pressure building. The same applies to the Christchurch CBD office market after more than a decade in the doldrums.

The industrial sector is well-positioned, with good demand from a range of users. Meanwhile supply, as is usually the case, is not getting too carried away.

The retail sector has enjoyed stronger-than-expected sales growth recently, with that momentum continuing. Sales growth tends to drive rental growth, with a lag of about 12 months.

Investor confidence in the retail sector remains high, with many retail developments and extensions under way or planned.

Finally, interest rates have settled at historically low levels, and while they will likely soften over the second half of the year, we're not talking about a blow-out.

To date most yields haven't moved. This means the leveraging opportunities afforded by property are strong, with the prospect of future capital gains as market fundamentals continue to improve.

In addition for overseas investors, there is the prospect of foreign exchange gains going forward.

All things considered it is a great property outlook.

So where are the opportunities to invest and what are some of the potential pitfalls?

In broad terms, investors looking to put money into property have a choice between direct and indirect property.

Direct investment (buying actual property oneself) for most individuals has been confined to residential property, where the barriers to entry in terms of cost and management are low.

For those wanting to invest in commercial property, most investors take the indirect route, that is, by buying an interest in a wholesale fund, unlisted trust, syndicate, property bonds, contributory mortgages or listed property vehicle.

However, if an investor is looking for solid performance with low risk and is not resourced to trawl through the details of a property investment, he or she should look to invest in large, multi-asset portfolios.

Witness here the large number of investors in commercial property in New Zealand over the recent past who have been badly burned.

Some rules of thumb. Remember diversification in property investment is as important as any other asset class.

Single or dual-asset vehicles concentrate your risk and may fail to deliver a viable exit strategy and often do not stack up to detailed scrutiny.

Consumer magazine has run some informative articles on these vehicles in recent years.

Mortgage bonds and property bonds (like all property investments) should be tightly scrutinised to see if the interest rates truly reflect the risk.

Remember that these bonds are not the same as a term deposit. Similarly question the flexibility of unlisted trusts that claim a secondary market.

You should take a close look at the reality of these markets to see if they are actually liquid rather than just a quasi matchmaking service. How often do trades take place? And what are the exit prices like compared to the entry prices.

Check out the Securities Commission's March 2000 report on these vehicles too.

Location remains a key component for any property investment. Get a feel for the location of the properties in any portfolio you're considering, listed or unlisted.

Ditto the quality of properties. What about the tenants and lease terms - if this information isn't available, ask for it.

Most importantly, however, get a feel for the quality of the portfolio and asset management behind your investments.

Is the manager experienced and financially sound? Do they have a strong track record of property management? Does a well-known, well-regarded company back them?

Also important is whether the fees are fair and reasonable. Is there double dipping or ticket clipping going on?

Watch out for promoters who have no long-term interest or exposure to how the investment will perform and pay intermediaries big fees to sell their products.

Ask your intermediary how much they will make out of your investment. The law requires them to disclose this to you.

It's reasonable to expect a lot from your adviser - you are paying for that advice.

Finally, investors themselves need to get smarter and wiser, take some responsibility for their investment decisions and stop giving their money to people who don't much care whether they are able to ultimately give it back.

Products (more often diversified) backed by large wholesale funds are a good way to go for the medium- to long-term investor, namely those who wish to take full advantage of a property cycle (seven to 10 years).

For those who want greater hands-on control, transparency and liquidity, listed property vehicles should be considered.

Investors have the option to either mix and match sector-specific vehicles or alternatively go down the diversified path.

Best of all, they can be sure of being able to sell their investment at any time.

In the current low interest rate environment there will undoubtedly be a large number of property offerings over the course of the year offering investors very attractive returns.

By following some relatively simple rules of thumb investors can ensure that they get not only the return on the way through but also their money back at the end.

Steve O'Malley is a property research analyst with AMP Henderson Global Investors

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