Add falling house prices on-top of interest rate cuts and Lenders Mortgage Insurance (LMI) – which has whittled down mandatory deposits to sit at just 5% of a property’s value – first-time buyers have been offered a helping hand into the realm of home ownership. It must be an opportune time to take advantage and enter the market for the first time – right?
Recent figures at first glance might indicate so. According to the Australian Bureau of Statistics (ABS), in February, home loans issued to first-home buyers increased by 1.8%, and the share of first-home buyers that made up new lending figures rose from 26.8% to 27.1%.
But ABS chief economist Bruce Hockman said recent lending figures came in soft, still being unable to match the peak of lending as seen in August 2017, and even despite February recording an 8.2% rise in lending commitments.
Households are still under strain – no better encapsulated than with the Reserve Bank’s recent interpretation of ABS figures, revealing that in December 2018, household debt hit 189.6% of disposable income, and housing debt also at a ground-breaking 140.2%.
‘Borrowing power’ has been strived for by prospective buyers, as much as they have been assessed on it by the banks. Those who haven’t yet made confident stride to secure a home loan might be wondering, searching, asking: What’s another way to make it happen?
Alternate methods to saving for a first-home have started to enter the vernacular, one of these being fractional property investing; a platform that also marks the first wave of disruption to Australia’s residential property investment market.
Whilst on the one hand, capitalising on assets through this means ultimately involves the buyer having to slide into the shoes of an investor, on the upper hand, it can be done for a slice of the buy-in cost.
Director of OpenCorp and leading expert in fractional property investing, Matthew Lewison shares how the platform could help with tapping into the market.
“It is definitely possible [for first-time home buyers] to invest in a fractional property investment. It won't affect the first home buyers grant for the investor as they are buying a financial product,” Lewison says.
“How long it will take is dependent on how much the investor contributes through a savings plan and how much market growth they get. The best thing about using a stake in property to help save for your first deposit is that it stops the market from running away from you.”
However, it’s also important to note that whilst the growth of the market can have a buyer seeing their return on investment grow, from dollar to dollar, so will their deposit requirement.
Being in the market helps a prospective buyer to remain on target, but actively saving still plays the most important role in reaching the end-goal, Lewison says.
How does fractional property investing work?
Fractional property investing operates through the means of a functional secondary market, which nestles the platform neatly into the ‘liquid investment’ category, whereby a fund manager or independent third party keeps the wheels turning. But what is effectively being operated, or sustained?
Put simply, it’s the selling and re-selling of individual units or ‘bricks’ that belong to a greater asset.
The fund manager begins by purchasing an asset or complex, followed by splitting up the asset into individual units, and then selling these units onto investors who are interested in profiting from a share in the entire asset’s market growth.
“If the property is purchased by the fund for $500k then the manager will issue 10,000 units – sometimes called financial bricks,” Lewison explains.
“Each unit therefore entitles the owner to 1/10,000th of the underlying asset. If the asset value goes up by, say $10k, the value of each unit relating to that asset will increase by $1, equal to a 2% increase for the investor.”
If the buyer of the unit is ready to determine how much profit or losses their share has generated, they will only be able to obtain the full figure once they sell their unit on the open market, or until the entire asset in which the unit sits in, is sold. Each investor then goes on to pocket their bought-in share of the asset’s sold price.
Lewison doesn’t believe fractional property investing will be an exciting tune for those aiming to ‘get rich fast’, as income returns can be fairly minimal. Because the investor is relying on the market to pick-up in growth, their unit or brick would only increase in value in relation to market activity. So, say the market threw 10% growth, a unit’s value would also increase by 10%.
Whilst investors might opt into the cycle of buying and selling their bricks frequently, set on reaping a speedy profit, Lewison flags the transaction costs that can apply, which can potentially increase the risk of such a process quickly eroding an investor’s capital.
The buy and hold strategy, when it comes to property investment, still makes the most sense to the director.
However, whilst fractional property investing won’t make you wealthy overnight, Lewison looks to historical records to shed light on the rewards behind such a strategy.
“To give some context, the Australian property market has been the best performing asset class over the last 30 years with only 4 short periods of negative growth,” he says.
“If an investor could have contributed $100 per week in a portfolio of Australian property market, starting in 1988 without any gearing, and assuming the portfolio at least matched the average rental yield of 3% and annual capital growth of 8.7% seen across the Australian market, that investor would today have $1.2m in net assets with their total contributions being just $166,400.”
And that’s not a bad return, keeping in mind that no debt was taken out to reach that figure. But that’s also not to forget the time it took to get there; the longer an investor is in it, the likelihood of a more substantial return. In this way, fractional property investing is very much a slow-burner.
It’s also worth noting that the future is largely unwritten, only ‘forecasts’ and ‘predictions’ dominating news headlines, with the property market throwing its own swings and dips. So, for those starting to invest now, returns ultimately depend on how the market reacts going forward.
What’s the minimum amount needed to start to invest in fractional property investing?
This is where fractional property investing has made a bit of a name for itself. An interested investor can start investing with just a portion of a single pay check; allowing for a more diversified pool of participants to take part in the platform.
A low barrier to entry also helps to subdue some of the pressure that can often come with handing over capital to the fate of gain and loss.
“Theoretically, investors looking to get started in fractional investment can kick off with just $50,” Lewison reveals.
“The fractional investment platforms offer a range of properties, from houses in regional areas to apartments in inner or beachside suburbs.”
Whilst the power rests with the investor, in being able to decide what properties will gain their money, Lewison reveals that the options fluctuate and they largely depend on what properties are available at a point in time – whether they be new assets bought by the fund, hot-off the market, or already acquired units that are being offered-up for re-sale by another investor.
However, Lewison advises investors, especially first-timers, to be vigilant and seek the advice of a qualified and experienced financial professional, no matter how little they choose to invest into the market.
“Don’t get caught up with the fancy packaging,” he says.
“At the end of the day, investors should invariably be looking for an investment that achieves their medium to long term financial goals while balancing the risks that they are prepared to expose themselves to.”
The benefits of fractional property investing
For many who are managing household finances and tending to other expenses, entering the market isn’t usually going to be a quick turn-around.
But since fractional property investing permits entry to those who are only able to tap into smaller investment amounts, it means the length of time it can usually take for them to start interacting with the residential property market is cut down.
In other words, entry becomes more viable, along with the added nudge of encouragement provided by not needing to take out a loan.
“Investors can also save time, as a lot of the work is done for them in securing and managing the properties,” Lewison says.
Investors are able disperse their money across multiple properties, rather than it being tied to just the one.
Furthermore, they don’t have to be responsible for the up-keep or re-sale of the property, with the fund manager filling this role.
However, it’s worth keeping in mind that if an investor contributes a smaller amount, it’s unlikely they will pocket a high return. But it could mean a more controlled return, in stages, which can build-up into a deposit over time.
And being able to control the reigns a little bit more, in what can often be volatile territory, is of value – especially relevant to those new to investing, tending to other financial commitments, or not having enough room to move when it comes to saving for a deposit from scratch.
“The great advantage of a low cost to entry is that you can dip your toe in the water and see how the investment and [fund] manager performs,” Lewison says.
“If the performance is positive, then you can increase your investment. Most of these platforms offer regular savings plans and distribution reinvestment plans, which allows you to add to your balance on a monthly basis similar to a bank savings account.”
However, Lewison also explains how entering the market through fractional property investing won’t allow an investor to place all their eggs in the one basket.
“You are potentially trading off higher returns, which you could achieve when buying direct property in your own name, with getting early access to the market and easier diversification,” he says.
Know the risks of fractional property investing
There are a number of important risks to consider about fractional property investing, and Lewison underlines some of these:
- Spreading capital across multiple under-performing investments; if decisions are made without careful research and objective, or if done without the advice of a qualified financial professional.
- Securing tenants could be more difficult than first expected, and rental income doesn’t level with forecast results.
- The secondary market for selling units could shrink in demand, leaving investors unable to exit until the manager or trustee decides to sell the greater asset.
- Strict compliance laws govern managed funds, such as in the case of fractional property investing. “The manager or trustees of these offerings may determine that their business model is unviable and close down their business,” Lewison says.
- An asset can only be sold after majority unit holders vote on it and selling an asset can only occur following a 5 to 7-year holding period. This can pose a problem to investors who need the asset to be sold in order to exit on underperforming units.
- Fractional property investing relies on a functional secondary market – “Therefore, your real liquidity hangs 100% on the secondary market for the resale of financial bricks,” Lewison says.
- But the market is also not as transparent as others, meaning that it is more vulnerable to being shaped by the fund manager.
“There exists a strong potential for the manager to arrange related parties to buy-up offered units to give the appearance of a functional secondary market,” Lewison explains.
And once any artificial demand is withdrawn, investors could find themselves in an ‘illiquid investment’.
Buyers or investors interested in exploring fractional property investing are advised to implore the advice of a financial adviser, and someone well-versed on the perks and risks that come with fractional property investing.
An experienced and qualified professional is able to guide you through the investing process and determine whether such a platform is best aligned to your goals and financial situation prior to you commencing.