The characteristics of commercial property as an asset class have changed since the COVID-19 pandemic. Ron Marney takes a look at whether its inclusion in an SMSF portfolio still has merit.
For many years, office property has been an investment staple for many SMSF trustees approaching retirement or in pension phase. As an investment, it offered things retirees prize: steady rental income, relatively high yields, long leases, professional tenants, the prospect of capital growth and access to respected fund managers such as Dexus, GPT and Centuria.
For trustees distrusting of equities but needing more income than term deposits could offer, office property was an obvious choice. It felt tangible, the ‘bricks and mortar sentiment’, understandable and conservative.
Then came the global pandemic that fundamentally changed this investment equation, with the permanent shift of many employees to a hybrid work pattern forcing a fundamental reassessment of office property.
The office has not disappeared. It never will. But its role has dramatically changed. Tenants are using space differently. Many want less but better space. Staff expect flexibility. Employers want offices that help attract workers back: better location, stronger environmental credentials, end-of-trip facilities, natural light, transport access, collaboration space and nearby amenities.
Melbourne-based office property developer and fund manager Castlerock chief executive Adam Bronts acknowledges this asset class is encountering strong headwinds. Owners need to offer high incentives to attract tenants and property values are stagnating.
But Bronts remains optimistic, arguing the office is vitally important for face-to-face communications, mutual learning and team integration as artificial intelligence starts to infiltrate the work environment.
Castlerock has benefited by focusing its portfolio on government-leased offices that have historically shown to be excellent long-term occupiers, provided their accommodation needs and benchmarks are met.
“We see the government-leased office play as one that generates consistent long-term income streams to provide stable returns to our investors,” Bronts says.
Solid government tenants versus finicky private sector tenants is just one market dynamic. More significantly, the office market is increasingly divided between prime assets and secondary stock. High-quality buildings in strong central business district locations can still attract tenants. Older buildings, suburban offices and poorly located secondary assets can face persistent vacancy, falling effective rents, higher incentives and expensive refurbishment requirements.
There is another factor at play, as Bronts explains.
“With construction costs unlikely to return to pre-COVID levels, we’re seeing limited new supply come to market that, in turn, will start to put pressure on rentals. We’re now seeing rental growth for new buildings that will trickle through the market in due time,” he points out.
For SMSF trustees, this is critical as the prime attraction of office property remains income. A well-leased office building can deliver regular rent, often with fixed or consumer price index-linked increases. For retirees drawing pension payments from their SMSF, this is more than useful. Commercial leases are usually longer than residential leases and tenants often pay many of the outgoings. In the right asset, with the right tenant and a sensible debt level, office property can still provide a relatively defensive income stream.
There is also a diversification argument. SMSFs are often heavily exposed to Australian shares, cash, term deposits and residential property. Commercial property can provide a different return driver. For business-owner trustees, business real property can also be attractive because, subject to strict rules, an SMSF may own commercial premises leased to a related business on arm’s-length terms. That has made offices, warehouses and professional suites popular with some small-business owners.
Certainly, it’s a trend Link Wealth Group managing director Steve Sloane is observing. Sloane says many clients are still setting up SMSFs to buy office space as diversification away from residential real estate in order to earn higher yields. Falling prices have also made this investment option more attractive, with Sloane arguing, for clients wanting a good long-term investment, office property is “worth considering”.
He doesn’t deny clients are charier about office property.
“All the media attention about this asset class over the past few years has made investors a little nervous. But at the end of the day it comes down to not having all your eggs in one basket. The right asset class in the right portfolios is what stacks up and this is where good advice can add a lot of value,” he suggests.
None of this denies there are risks associated with this asset class that cannot be ignored.
The first is vacancy. An empty office is not like a vacant house. Re-leasing can take months or even years. Incentives can be large. A landlord may need to fund fit-outs, rent-free periods, leasing commissions and building upgrades before income resumes. For an SMSF in pension phase, a long vacancy can create a cash-flow problem at precisely the wrong time.
The second risk is valuation. Office property values have been hit by higher interest rates, weaker tenant demand in some locations and uncertainty over future office usage. When discount rates rise, property valuations usually fall. For unlisted property funds, those valuation changes can appear slowly through periodic revaluations. For listed real estate investment trusts (REIT), they appear immediately in the unit price. Neither is necessarily ‘safer’; they simply reveal risk at different speeds.
The third risk is asset quality with the market putting a premium on quality and punishing obsolescence.
The fourth risk is liquidity. Direct office property is highly illiquid. Selling a commercial property can take time, particularly in a weak market. Unlisted funds may also restrict withdrawals during periods of stress. This is a major issue for SMSF trustees who need liquidity to pay pensions, meet tax liabilities or rebalance portfolios. Retirees can tolerate some illiquidity, but they cannot ignore it.
For Brisbane-based financial adviser Helen Nan, who typically shies away from recommending direct commercial property to her clients, liquidity remains the critical issue.
“Most of my clients are pre-retirees or are retired, and for this group, liquidity is a critical consideration. A key question is whether property is the right vehicle to generate sufficient and reliable retirement income and for many investors the answer is typically no,” Nan indicates.
The fifth issue is concentration. A direct office suite or small commercial building may represent a large share of an SMSF’s assets. If the tenant leaves, the fund’s income can fall sharply. If the building needs major works, the fund may have limited flexibility. Diversification is not just an investment theory; in retirement, it is a practical risk-control tool.
This is where REITs have a strong argument, providing exposure to diversified portfolios of property without requiring trustees to buy a building directly. They are liquid, transparent and professionally managed. Investors can enter or exit on the Australian Securities Exchange. They receive regular reporting, market pricing and, usually, diversified tenant and asset exposure. For SMSFs, that liquidity is valuable.
REITs also allow trustees to adjust exposure. An SMSF can own a modest allocation to office property through a listed trust rather than committing a large slice of the fund to one building or one unlisted vehicle. Trustees can also choose diversified REITs that hold industrial, retail, logistics, healthcare or social infrastructure assets alongside office property, reducing reliance on a single challenged sector.
In Nan’s opinion, property trusts can provide a more suitable alternative for clients seeking exposure to the property market while maintaining liquidity.
“In particular, REITs offer better transparency, diversification and ease of access compared to direct ownership or unlisted structures,” she says.
However, REITs do have drawbacks. They are listed securities so their prices can move sharply with equity-market sentiment, bond yields and investor risk appetite. A retiree who expected ‘property-like’ stability may be surprised by REIT price volatility. Listed REITs can trade at discounts or premiums to net tangible assets. They can also be affected by management decisions, balance sheet leverage and capital raisings.
Unlisted property funds sit somewhere between direct property and REITs. Their appeal is smoother pricing, professional management and access to institutional-grade assets. For SMSF trustees, a quality unlisted office fund can provide income without the daily market volatility of listed REITs.
The trade-off is liquidity. Withdrawal windows may be limited, queues can form and redemptions can be suspended if too many investors want out. Trustees must read the liquidity terms carefully and understand the fund’s debt, lease expiry profile, tenant concentration and valuation policy.
Direct investment remains the most specialised option. It may suit SMSFs with large balances, strong cash reserves, low debt, commercial property experience and a clear reason for owning a particular asset, for example, business premises leased to a related entity under proper commercial terms. But it is rarely ideal for smaller SMSFs seeking simple retirement income. The risks of vacancy, capital expenditure and concentration are too high.
The central question for trustees is not whether office property is good or bad; it is whether the particular exposure suits the fund’s retirement objectives.
For trustees heading into retirement, the priority should be sustainable income, liquidity, diversification and capital preservation. Office property can still help, but only selectively. Prime assets with strong tenants, long leases, conservative gearing and credible managers remain investable. Secondary assets with weak leasing prospects, high refurbishment needs and optimistic valuations deserve caution.
The golden age when office property could be bought almost automatically for income and growth has passed. The asset class is not broken, but it is more selective. For SMSF trustees, that means doing what good trustees should always do: look past the label, understand the asset, test the income, question the valuation, manage liquidity and avoid confusing a familiar investment with a low-risk one.
