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Overlooked Property Hot Spots
BY ELIZABETH MORAN - 28/04/2017 | VIEW MORE FIXED INTEREST ARTICLES

The residential property merry go round is always good, until it stops. Just ask some Perth home owners and investors.

While the good times are well and truly over in the west, the hype around the Sydney and Melbourne housing markets seems to be more infectious than ever, creating an urgency to invest or miss out.  But, if you stand back and assess residential property as just another investment, it doesn’t always stack up.

Maintenance, real estate agent fees, stamp duty, rates, insurance, vacancy periods and changing property markets mean even with the best intentions, investing in physical property can result in an overall loss.

Rapidly rising property prices in Sydney and Melbourne have put pressure on rental yields, which are at record lows according to CoreLogic. For a house in Sydney the gross yield excluding costs was 2.8 per cent in January, while in Melbourne it was 2.7 percent, indicating investors are chasing capital growth. What happens if the market changes and prices go backwards?

Investing in property doesn’t have to be such a big gamble.

There are two hot spots that you may not be aware of – investing in property bonds and residential mortgage backed securities (RMBS).

Property bonds

Many of Australia’s largest and medium sized property companies issue bonds. The great advantage of bonds is that you know what your return will be and the date you can expect to be repaid the $100 face value of the bond, providing greater certainty than direct property investment. Yield to maturity ranges from 3.06 per cent for a Mirvac bond maturing in September 2020 to 7.45 per cent for an Impact bond maturing in February 2021.

Investing in property bonds means giving up the dream of fantastic capital gains and sure, you may not “make a million”, but there’s less downside risk.

Company Maturity date Yield to maturity Income/running yield Minimum face value investment
Mirvac 18/09/2020 3.06% 5.29% $500,000
Stockland 25/11/2020 3.14% 7.03% $10,000
Stockland 23/11/2022 3.43% 4.27% $10,000
Mirvac 18/09/2023 3.74% 3.55% $500,000
Sunland 25/11/2020 6.20% 7.24% $10,000
W A Stockwell 29/06/2021 6.32% 7.49% $10,000
Impact Group 12/02/2021 7.45% 8.26% $10,000

Source: FIIG Securities
Prices accurate as of 6 April 2017 but subject to change
All bonds are senior debt and fixed rate
Red = wholesale, black = retail

It’s interesting to note that all of the yields available on property bonds are higher than the gross rental yields on Sydney and Melbourne houses.

Late last month, property company Villa World issued a $50 million simple corporate bond via the ASX, maturing in April 2022. Unlike the fixed rate bonds mentioned above, this one is floating rate and priced at 90 day BBSW plus a margin of 4.75 per cent providing an initial yield of 6.55 per cent annualised for the first quarter.

Residential mortgage backed securities

One of our favoured investments at the moment is Residential Mortgage Backed Securities (RMBS); in fact we think there is no better place for capital looking for an investment grade home. RMBS are issued by financial institutions to recapitalise their balance sheets. Hundreds and sometimes thousands of loans are pooled together via a trust. The trust breaks the combined pool into smaller, marketable classes (tranches), making the RMBS attractive to investors.

In this way, the tranches act like a normal company capital structure, where investors with the lowest risk appetite target the senior bonds (or in the case of RMBS, the highest rated tranches) and those with a higher risk appetite target the lower ranked capital, like hybrids or shares (or in the case of RMBS, the lowest rated tranches).

Different tranches of RMBS offer a spectrum of risk although, given the structure, the majority are typically low risk due to high underwriting standards, conservative loan to value ratios (averaging around 70%) and the fact that loans retain full recourse to the borrower if selling the property can’t recover the borrowed funds.

Many of the problems investors face with direct property such as illiquidity and transaction costs are mitigated by investing in RMBS.

RMBS pass through the principal repayments from the pool of mortgages, unlike bonds that pay interest and principal at maturity, so RMBS terms can be quite short. Income is set up-front and is based on a margin over a benchmark, usually the bank bill swap rate (BBSW).

For example the highest ranking class RMBS in the most recent Bendigo and Adelaide Bank Torrens 2017-1 issue, rated AAA, will pay 1 month BBSW 113 basis points, around 2.75 per cent per annum, on a quarterly basis. The weighted average life, or expected term to maturity of this class is just 2.9 years. Whereas the lowest investment grade tranche, rated AA pays BBSW plus 250 basis points, around 4.12 per cent per annum.

Recent RMBS issues – credit ratings and pricing


Source: FIIG Securities, KangaNews

RMBS offer investors a known return that specifically targets their risk appetite, with security over the mortgages and the benefit of lenders mortgage insurance on high loan to valuation mortgages. They can also offer liquidity, and a less stressful investment as the problems of occupancy and maintenance as well as the cost of borrowing are borne by the owners of the properties.

Most superannuation funds and bond funds will invest in RMBS. As they can only be accessed in the over the counter bond market, individual investors must find a bond broker that can transact on their behalf.

Demand for these low risk investments is high. FIIG Securities make RMBS available to wholesale investors from $50,000, as the bonds become available in the secondary market.


Elizabeth Moran is a director of education and fixed income at Sydney-based bond broker, FIIG Securities.

She is a specialist on the bond market and regularly presents at conferences across Australia. Elizabeth is the editor of FIIG's weekly newsletter The Wire and is the is the author of "The Australian Guide to Fixed Income".



 

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