Cashflow can be a killer, but it’s on tap in this segment right now.
Cashflow is always a killer.
It can bring down otherwise healthy businesses, it can derail otherwise successful portfolios.
And in the early days investors will often go for equity and capital gain. Nothing impresses people like a portfolio worth millions.
But by the time they realise they need cashflow to keep the whole show running, it can be too late.
And this is a tough cashflow environment right now. If you look at what’s happened to yields in residential property over recent years, we’ve seen a compression that’s taken them back to bare bones at best.
I mean, look at the latest data from CoreLogic:
In Melbourne Gross (and that’s gross!) yields are a smidgen over 3%. In Sydney they’re not much better at 3.2%.
I don’t know how you make it work with gross yields of 3%, and really, if that’s what buyers are accepting, then they’re probably not trying hard enough.
And yields get a little better when you move out to the smaller capitals, but not all that much.
Right now in residential property, there’s not a lot of cashflow for investors to hang their hat on. You can still get good returns, you can still get cashflow positive properties, but you’ve got to search a little harder – put a little more time in.
And that was all well and good when interest rates kept heading down and capital values kept heading north, but the APRA restrictions are seeing interest rates nudge up, with the threat of even more nudging in the offing.
Cashflow could become the make or break issue more many investors in 2019.
And in that context, I found this article in the AFR about BIS Oxford’s commercial property outlook interesting.
It noted that the past 5 years have seen a massive boom in commercial property, especially in office and industrial.
There were points there where the Internal Rate of Return (more or less equal to Gross Yields) were running at close to 20% in Sydney Offices!
BIS notes that these levels were never going to be sustainable, and over the next five years, they are going to be wound back.
But this is the thing. Even with them winding back (which is itself due to prices catching up and growing faster than rents, rather than rents falling), we’re still looking yields in Sydney and Melbourne around the 7-8% mark.
Don’t you feel sorry for those commercial property investors – having to suffer through yields of 7-8%? I might send them a Christmas card.
And this is for offices and industrial, and those commercial segments tend to be dominated by CBD offices and large industrial centres. Smaller scale commercial investments – the kinds of things easily accessible to ‘mum and dad’ type investors – those things typically come with a yield premium.
So 8 or 9%, even 10% is easily achievable – if you know what you’re looking for. (You need to know what you’re looking for.)
But how is this possible? How is commercial property still delivering this kind of cash flow to investors, while residential property is just slugging along?
The thing to remember is that residential property is being held back by a string of recent APRA restrictions – restrictions specifically designed to slow the market down.
APRA never threw the hand-brake on commercial.
I mean, compare the APRA restrictions put on the two sectors over the past 18 months or so:
• Investor lending growth capped at 10% pa.
• Interest Only lending capped at 30% of new loans
• Much tighter income and expense reporting
• Compulsory Credit Reporting across the financial sector
• Corrected typo on p.17 of ADI Commercial Lending form.
That is, APRA hasn’t hassled commercial the same way it has hassled residential. And so commercial is still tracking in line with the economic fundamentals – where economic activity is picking up and unemployment remains low.
So even as the hectic pace of the recent five years unwinds, we’re coming back to some very solid fundamentals.
Which means the yield, and even the capital growth outlook for the right commercial properties is still very, very strong.
That means, for cashflow hungry investors, commercial property could be a strong option.
Most investors won’t touch commercial – and really, they probably shouldn’t. The cross-over from residential to commercial isn’t hard to make, but there are some important things you need to be aware of.
But personally, since I happen to like cashflow very, very much, I could see the balance of my purchases in 2019 tipping more and more towards commercial… at least until the APRA restrictions wash through.
I mean, we all like cashflow, right?