Pros and cons of buying property or investing in real estate debt funds

The Australian real estate market has long been a favoured investment vehicle for individuals seeking to build wealth.

The allure of owning tangible assets and the potential for significant capital growth make property investment an attractive option.

Historically, Australian property values have shown a consistent upward trajectory, with an average annual growth rate of approximately 6.8 per cent over the past 25 years. This capital appreciation, coupled with the potential for rental income, can provide a dual revenue stream that enhances the overall return on investment.

In contrast, a real estate debt fund pools funds from investors to invest in loans secured by real estate and, in return, provides investors a consistent, passive high-yield income secured against property.

This has become an increasingly popular investment choice over the last few years, with some analysts calling it the “alternative asset class of the year”.

These funds provide investors with exposure to the property market, with lower entry costs, professional management and greater liquidity and flexibility compared to direct property investment.

Frances MacDonald, Director at Australian real estate debt fund Capstone Income Fund, said investing into a real estate debt fund allows investors to profit from property with less risk, less effort and lower entry costs, and has been increasingly popular with investors for its stability while still achieving double digit returns.

“Capstone Income Fund provides investors with a 10 per cent annual return target with monthly distributions, no lock up period, unique security features and investment starting from $100,000 – an attractive alternative to direct real estate investment,” Mrs MacDonald said.

The pros and cons of each strategy are weighed up below:

Direct property investment: pros and cons

Pros:

1. Capital growth: direct property ownership can provide significant capital growth.
2. Rental income: owning property can generate a steady stream of rental income.
3. Tax benefits: investors can benefit from tax deductions on depreciation, interest on loans and maintenance expenses.
4. Tangible asset: property is a tangible asset, providing a sense of security and control.
5. Leverage: property ownership allows for leveraging through mortgages, potentially amplifying returns on investment.

Cons:

1. High entry costs: high entry costs associated with purchasing property can be prohibitive for many investors, with the median house price in Brisbane now exceeding $937,000 making it the second most expensive city in Australia.
2. Illiquidity: real estate is not a liquid asset, and selling property can be time-consuming.
3. Market volatility: property values and rental yields are subject to volatility and returns are not guaranteed.
4. Management hassles: direct property investment requires active management and can be time-consuming and stressful.
5. Debt repayment priority: in the event of financial distress, debt is repaid before equity, potentially leaving property owners with little to no return.

Real estate debt funds: pros and cons

Pros:

1. Lower entry costs: investing in a real estate debt fund requires a lower initial investment compared to purchasing property directly.
2. Diversification: diversified funds pool investments across various properties and locations, spreading risk.
3. Liquidity: investors can redeem their units in the fund with greater ease and speed, providing flexibility.
4. Professional management: experienced professionals handle all aspects of the investment, reducing the burden on individual investors.
5. Stable income: real estate debt funds generate income through interest payments on loans secured by properties, often with lower volatility than rental income.
6. Competitive returns: debt funds offer high yield returns, with recent trends starting from 6 to 8 per cent per annum.
7. Debt repayment priority: in the event of financial distress, debt is repaid before equity, providing a greater level of security over returns.

Cons:

1. No tangible ownership: investors do not own the underlying properties, which can be a disadvantage for those who prefer direct ownership and control.
2. Fees: investing in a fund requires fees for investment management.
3. No leverage: Investments in debt funds are not geared up by a mortgage, meaning the potential for leveraging returns is lower compared to property ownership.
4. Market dependency: real estate debt funds are still influenced by broader property market conditions and economic changes, although it is higher in the capital stack and repaid before equity.

High yields and financial balance

While direct real estate investment and debt fund investment each have their merits, the choice ultimately depends on an investor’s financial goals, risk tolerance, and preference for management involvement.

Funds offer a compelling alternative for those seeking to enjoy high yield returns, minimise risk, reduce management hassles, and enjoy greater liquidity.

By spreading investments across various properties and leveraging professional management, real estate debt funds can provide a balanced approach to real estate investment, appealing to seasoned investors and those new to the market.