Most people consider property to be the largest alternative asset in Australia, which includes residential, commercial, agricultural and industrial.
Within those sectors, there are three primary types of investment strategies: property equity, property debt and property options.
The property asset class is a market sector where you will deal with insiders (property developers/ builders) with access to asymmetric information and capital raisers with conflicts of interests. This can lead to decision making that’s not always in the best interests of the investor.
Let’s take a closer look at the types of property investment strategies that will even the playing field.
Equity
There are two main types of property equity: project-based property development and established assets.
If you invest in the equity of established assets such as a fully leased office building, shopping centre or childcare centre, you’ll be buying the equity for potential upside in the value of the property and for the income it generates.
Whereas, putting equity into a development is akin to being an armchair developer – you relax while the developer does the work. The risk here is that your success is driven by the success of the developer and the project.
Property options
Another way to invest is through a property option, which is a contract between two parties that gives the buyer the right to buy or sell an underlying asset at a predetermined price at a specified time in the future.
This means you can ‘lock in’ an optional buy or sell price for, say, three months’ time, giving you price certainty. The key with options is the leverage that’s factored into them.
Option leverage is great once you get above the breakeven point. In options, breakeven is the point at which the asset price appreciation equals the amount of premium you paid.
Debt
Investing in property debt has become common in private markets. It has become so mainstream and commoditised, you could argue that it’s no longer an alternative asset.
When an asset class is saturated with a supply of cheap capital, it means an excess supply of capital goes into that market.
An excess supply of capital means the borrower can get cheaper interest rates, which is great for the borrower. It’s basic economics: the supply-and-demand equation (excess of capital) is in the developer’s favour, which simply means the relative return on investing in property debt isn’t there.
Grow Your Wealth Faster with Alternative Assets by Travis Miller.
Capital structure
This is a topic to get your head around; it is the risk-return of investing in property debt.
1. Senior loans
The lowest risk debt is the senior secured loan and is the first to get repaid and the last to lose money. The investment opportunities in this area vary widely, although the most common are development loans, land bank loans, and high loan-to-value ratio (LVR) loans.
It’s an area where the banks – the cheapest lenders – don’t typically want to play, primarily because they tend to be considered more complex projects or loans. Banks tend to play in the more mature, later stage and completed assets.
2. Junior secured loan
This type of loan behaves pretty much like a senior loan, but it ranks behind the senior one in the repayment waterfall.
A repayment waterfall is the order in which creditors are repaid if there is an insolvency or exit situation.
For example, the senior lender is paid first, the junior lender is paid second and the owner (or the equity holder) is paid last (if there’s anything left over).
From the junior lender’s perspective, if there are losses on the project, the junior lender will lose money after the owner, but before the senior lender.
3. Mezzanine loan
Mezzanine finance is where you register a second mortgage (a bit like a junior secured loan but documented differently) or you have a caveat, which is a right to register a second mortgage on the project.
You don’t get the first ranking security on the asset because it’s already been taken by whomever gave them the first mortgage. As a mezzanine financier, you only have security after the lenders who have the first mortgage.
4. Unsecured loan
The final loan type is unsecured debt.
This is where you hope to get your money back. You form a view on the sponsor and the developer, and you form a view on the project, cash flows and LVR. But you’ve literally got no security or any right to register security.
In asset allocation, it can be about the money you’re happy to risk. It’s an amount of money where you don’t really care about the risk-return because you have invested in all sorts of other things that might work, and you can afford to lose $10,000.
The property asset class is a diverse one, attracting investors with varying degrees of expertise and risk appetites. Therefore, it’s important to do your research.
Whether you invest in commercial, residential, agricultural or industrial property, it’s important to know the risks and returns for successful investing.
