Direct Property Investment V LPT's

Aside from the tax savings afforded by negative gearing, are there many other financial advantages to direct property investment rather than simply investing in LPT's (Property Funds).
I can think of numerous disadvantages such as holding costs, legal fees, troublesome tennants, but not many advantages.
Anybody think the same, or am I missing something obvious?

 

Hi Lorrimer,

Firstly, peoples experiences can be very varied. Some get a dream run while others suffer.

My experience with direct commercial investment was one of great suffering wth hopeless tenants. One went broke after being in business for over ten years. The next decided they wanted to break the lease after 12 months.

Who knows maybe the next one would have stayed for ten years and paid on time but I ended up selling for a 50% capital gain after 3 years which more than paid for the suffering,

I am enjoying my experience with LPT's emmensly.

For me it come down to this.

I dont like to rely on any individual because I find that the individual usually lets you down. Direct commercial is very much about the individual, tenant, and so the potential for dispair is high.

Residential is completly different because you are relying on the masses as tenants are a "dime a dozen".

LPT's are also in the relying on the masses category by size.

Whenever I have entered into any sort of enterprise which relys to heavily on another individual it has been unsatisfactory but......the great tenant may have been the next one.....Who knows.

Lets just say Direct commercial has greater risk and greater potential reward or disaster. Be sure you have plenty of equity to burn for the tough times.

Sorry to sound so negative but you asked for an opinion.

I would suggest that direct comercial should form no more than 25% of one total portfolio. IMHO, 2Cents.

MJK

 

Why do you think that you couldn't negative gear into LPTs?

 

I'd say the biggest advantage would be in the capital gains - does the LPT pass on the full capital gains to you.

In my case paid $275k for property 7 yrs ago in Sydney now worth $600k, another 5 yrs ago paid $380k now $650k.

Every 7 years - property doubles in Sydney

Rgds

Kevinb

 

It is interesting...lots of people look at commercial for income but I would agree with Kevin B the greatest advantage with commercial would be capital gain. Thats certainly what I got out of it.

You need to buy well for capital gain. The last 5 years have been kind for capital growth with the economy ticking along nicely.

If you are looking for steady income I'd go the LPT.

MJK

 

Gearing into both LPT's and Direct commercial is usually the same...70% max.

MJK

 

I'm betting that property won't double in Sydney between 2003 and 2010. But you never know...

 

LPTs pass on the same tax advantages of residential property to unit holders. There are many cases where they pass on greater tax deductions through depreciation, etc. Check the details of a few and you'll see how much of a difference this makes to the reported returns.

The big difference between LPTs and direct residential property is risk/volatility. Direct residential property has about 50% less financial risk than the average LPT. That's a big deal I think.

The other issue is that many of the current LPTs are listed as stapled securities that contain a security that represents business operations. So while you think you're investing in simple property that returns income through a lease, you're actually also investing in a business on the side. Whether that business is viable and profitable is another story, but it increases risk. It is very hard to lose all of your capital in a property (I'm thinking: no insurance + natural disaster), but fairly easy in a business. The upside is that you may see greater returns because the business may be doing well. Another upside is that the business is usually the property manager of the property and the LPT may be saving fees through hiring its own management (but this is debatable because savings may be achieved through scale/scope economies of larger property managers, maybe).

The other difference with LPTs and any direct property is that LPTs are more susceptible to market forces (since they're more liquid, more divisible and priced daily). So while in theory the LPT should be worth its intrinsic value, it may be momentarily inflated by market emotion. Direct property is much less active and less volatile, meaning you're more likely going to pay intrinsic value (although this is probably again debatable).

Anyway, this is all just personal opinion. I think LPTs a very cool, although with the prevalence of stapled securities, you have to remember you're investing partly in equities and macroeconomic forces could play a different role than to direct property. I really dislike direct property for all of the reasons above, but I've had a good run with commercial property. Our tenants are solid and never give any trouble. This is a great topic though; one I'm really interested in. I want to get my parents investing in LPTs for their retirement.

 

Kevinb,

The 7 year return you mention in your post equates to a compound yearly return of 11.79%. According to the ASX Russell Long Term Investing Report recently released (available on asx.com.au); LPT's have produced a compound return of 14% over the last 10 years! And you could've got that return by investing in an index with nothing to do - no tenant issues, etc. etc. This obviously doesn't mean they will do 14% in the next ten years ;-)

 

One more thing I thought I'd mention - its amazing how the general public investor thinks that negative gearing only applies to residential property investments. The real estate agents obviously did a good job in their marketing.......

 

Hi Gang,

The above mentioned risk can be significantly reduced by doing a little research and spreading your funds across multiple LPTs. Perhaps the safest option is to invest in an LPT Index fund. The fact that a single direct property investment of some quality ties up a relatively large sum of money in my mind is a significant disadvantage. Another un-insurable risk that people overlook is termites which causes very significant and costly damage to many properties including some which even have regular termite inspections and/or treatments. Another risk that seems to be happening more frequently lately is undesirable developments (eg large unit complexes) being built next to one's investment property. Due to shortage of land in inner areas in particular the council is rezoning land allowing large developments in what was originally zoned for low density. I think many people underestimate the risks associated with direct property especially when a single investment requires substatial funds.

Also later down the track if one wants to start moving some of their investments into Superannuation especially given the extremely favourable tax treatment about the come into effect being able to sell the LPTs spread over years with some tax planning would enable you to eliminate or significantly reduce CGT. Unfortunately you can't generally sell a Direct Property in parcels and hence a large one-off Capital gain will be difficult to reduce signicantly because of the limits on Super contributions. I could go on with more reasons but I think these are food for thought.

So in summary rather than tie up potentially $400K or a lot more in a single investment property one can diversify across many quality stocks and LPTs. In reality if one does this the risk is very low, the tax advantages great and the flexibility fantastic.

Cheers - Gordon

 

Gordon

All the points you mention are valid ones. I certainly agree that LPTs have their place. But it typically isn't $400k tied up in a direct property...it's perhaps more like $40-80k (plus outrageous stamp duty and ongoing land tax of course ).

Yes you can leverage up your returns in LPTs to 70%...but you can go to say 97% including LMI with direct residential. That extra gearing certainly adds additional risk, but it magnifies returns.

Of course horses for courses...and there's a lot to be said for the lack of tenant hassles with LPTs

 

But you can't get 97% with commercial. I would say more often only 70%.

MJK

 

I'm in that boat - don't have the time, money or expertise for either direct investment or to pick the "right" LPT winner, so I "bought the (LPT) market"" via listed SLF - Streetracks Property fund which basically mirrors the LPT index as I understand it.

Bought in early July @ $18.40, trading today @ $21.62, paid a distribution @30/9 of 0.24c per unit. Distributions are paid quarterly and yield is I think quoted at around 6% p.a. I've got no complaints - this isn't a recomendation, just sharing what I have done.

... forgot to add - LVR with BT is 70%

regards,

PA