Under the right set of circumstances, buying a block of units can be a great investment because it often comes at a good price, and the potential for capital returns and good rental income is high.
But the coronavirus pandemic has placed the entire property market under extraordinary circumstances – so investing in this type of property at this time also requires extraordinary caution.
Scott O’Neill, founder and director of property investment firm Rethink Investing, recommends investing in units blocks only “if the net yield stacks up.”
He says a “unit block with a 6% gross yield, but with outgoings that set back the net yield to 3%,” for example, is not a viable option. In such cases, he instead suggests “investing in another asset class for better cashflow,” like commercial properties “where net yield in capital cities can exceed 7%.”
However, O’Neill says investing in unit blocks amid all the market uncertainty still has its benefits.
“You can have multiple income streams, which can spread your income risk due to having multiple tenants,” he says. “The chance you have them vacant all at once would be very low.”
O’Neill adds that unit blocks give investors a lot of flexibility when the time to sell has come.
“There are often strata title opportunities that allow the split and selling of the units individually,” he says. “Yields are generally higher than standalone units or houses in the same suburb.”
Blocks of units don’t come cheap, and investors often need a considerable amount of money to pursue this option. O’Neill says lenders often treat three or more units under one title as a commercial loan, which requires a larger deposit.
He adds that “although there can be strata title opportunities, the works required to get them approved can often get very costly.”
“Firewall installations, for example, will erode the preserved profit margins of selling off individually,” he says. “Also, the market for selling units off individually might not be strong, especially in the COVID-19 environment.”
O’Neill says the council rates also increase once the property has been split up as the units become “individually metered and rated for council consumption purposes.”
“Although yields can be higher, so can the outgoings,” he says. “The maintenance can build up, especially when you have over four separate tenants in an older complex. The council and water rates are also going to be significantly more than the standard house.”
Residential or commercial: Where to invest?
According to O’Neill, commercial assets still yield “superior cashflow” compared to residential unit blocks.
“The key is to work out the true net figure by calculating the full rent minus all the outgoings such as rates, water, maintenance, insurance, allowance for vacancy, and rental management,” he says. “Once all these costs are accounted for, it’s rare to find a net yield that would match that in commercial.”
He says that tenants pay for the outgoings in commercial properties.
“Very high yielding properties with long leases will be in high demand as the residential markets show weaker growth prospects,” O’Neill says. “More people will flock to commercial for the cashflow that residential properties can’t offer.”
The future of Australia’s commercial property market
The COVID-19 pandemic has changed how many businesses operate, and O’Neill expects these changes to greatly influence the future of Australia’s commercial property market.
“Marketing spending may change,” he says. “Less money will be spent on [face-to-face interactions] like conferences and more spending will be allocated to online marketing. Retail shopfronts may find that operating 100% online could be a better financial option.”
“As a commercial investor you must think about how these types of changes may affect commercial assets. For example, I see strength in the industrial markets as local manufacturing grows and there is a greater need for storage as online sales boom.”
O’Neill adds that some businesses that use industrial properties are seemingly impervious to the impact of the pandemic.
“The majority of logistics, trade and storage-related businesses were able to operate even in the worst parts of the closure,” he says. “You should target essential service-type properties and industrial in most cases. If you stick to these types of properties, your odds of success will be greater in these strange times.”