In our last couple of blogs we have looked at the sectors of shares and cash in your SMSF (Self Managed Super Fund) and in this blog we look at direct property as a component of your Fund. The “chunky” nature of property means that a considerable outlay needs to be made to purchase it (even with a loan) and this may distort the asset allocation in the short term. For this reason the inflow of funds into the SMSF needs to be considered to see how long it will take to get the asset allocation back to the desired allocation. As many of you know, I am a conservative investor when it comes to property and that is why I like the guaranteed income for a long period of time and am willing to pay higher than average fees to ensure that expenses such as repairs and restorations are kept to a minimum. For this reason DHA houses (Defense Homes Australia) tick a lot of the boxes for me and – whilst they generally are not in areas that experience high capital growth – the “bankable” yield (rental return) is 4.5% – 5.5% so even small capital growth on top of this means a good return in the long term. Two other factors also come into play: probable rental increases over the period of the lease and the compounding effect of monthly payments. For example, if the yield was shown as 6%, this is the equivalent of a term deposit paying you 6% at the end of the year, whereas if you receive monthly rental payments of .5% (1/12th) and where able to reinvest this money at 6%, you would receive a “true” interest rate for the year of more than 6.153%.
Another possible property investment available at the moment is one that has many of the characteristics of DHA homes but with some important differences (which I will discuss shortly). Rio Tinto, rather than use fly-in-fly out for their executives in Weipa, in far North Queensland, are arranging for quality homes to be built (with swimming pools) and sold to the general public for around $440,000. These homes are then leased by Rio Tinto at a yield of 6.5% with very few outgoings and a 10 year lease guaranteed by the company.
On the face of it, these appear to be a better deal than the DHA homes but the important difference is the location. Weipa is 800 kms from any sizable town and is very much a mining town, so – if the bauxite being mined there runs out (which is highly unlikely because there is an estimated 50 years supply) or Rio Tinto for any reason closes their mining operations there – the chance of any capital gains would be remote.
In these circumstances, there is a risk being taken to achieve a high monthly return and – depending on your own personal circumstances (age, cash flow requirements, attitude to risk, etc.) this risk may or may not be acceptable.