BrickX versus limited recourse borrowing – which is better for SMSF property investors?

Earlier this year real estate investment start up BrickX launched their platform which enables investors – including SMSFs – to buy a piecemeal interest in individual residential properties.

Utilising a unit trust structure to provide multiple investors with ‘shares’ in an underlying property is not new.  Listed and unlisted unit trust structures have been around for many years and we’ve also recently seen a fractional property investment solution launched by DomaCom.

The real point of difference that BrickX provides investors is that they are effectively creating a market where the shares (or ‘bricks’) in the individual properties can be bought and sold openly with very little cost (2% purchase cost, $0 sale cost).  The transparency and liquidity this can provide is something residential property investors can’t currently access.

But would SMSF investors be better off buying an entire property via a limited recourse borrowing arrangement, or should you buy a number of bricks across a number of properties?

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Looking at the numbers

I undertook some basic analysis comparing an LRBA investment to a purchase of a portfolio of bricks via BrickX.  The results were not surprising.  Over a 10 year period assuming the same rates of income, expenses and capital growth, the LRBA returned more money into the investors pocket purely based on the leveraged nature of an LRBA compared to the unitised BrickX model.

Even accounting for the ability for a BrickX investor to re-invest surplus annual cash flow into additional bricks (i.e. dividend reinvestment), the LRBA option still provided approximately 10% more net cash proceeds over a 10 year period.

My analysis is not surprising as the use of leverage is widely accepted to boost returns – provided the underlying investment increases in value.

Diversification benefits

Any piecemeal or unitised investment has the benefit of enabling diversification compared to a direct, lumpy investment which is typical of an LRBA purchase.  For example rather than allocating $200,000 into one property via an LRBA, using BrickX an investor could invest $20,000 into ten separate properties.

By splitting the available funds across multiple properties, the financial Russian roulette of investing in a dud property is significantly reduced.  Working with my example, if the capital growth of the property purchased under the LRBA was only 3.00%, but the average on the BrickX portfolio of bricks was 5.00%, the BrickX investments would outperform by 13% over a 10 year period.

The option to diversify is a key benefit of investing on a piecemeal basis. Pouring all available funds into a single property is inherently dangerous and could have devastating effects if your investment choice is poor.  BrickX reduces this risk as it is unlikely that all bricks you choose would have the same capital returns – you would expect a mix of below average, average and stellar returns.

Selection of quality of underlying properties is key for both BrickX and investors utilising the platform.

Cash Flow

To my knowledge the BrickX trusts do not employ internal gearing, which means no interest costs and higher net rental dividend returns to investors.  Based on my simple analysis, annual cash flow returns (before the tax impact of depreciation) were about than four times higher via BrickX compared to an LRBA.

I utilised a LRBA loan interest rate of 5.05% in my analysis. At the time of writing, the RBA has just reduced the cash rate to a record low 2.00%.  It would be expected that over the longer term, the applicable interest rate would be higher.

LRBAs are more susceptible to changes in interest rates.  For example in my analysis if the interest rate on the LRBA loan was increased to from 5.05% to 7.05% the investment would run at a negative cash flow of almost $3,000 per annum.  Even if the same capital growth was maintained (unlikely in an environment of rising interest rates) the BrickX investment would just outperform the direct LRBA investment.

Where LRBA investments perform well in a market where interest rates are relatively low and capital growth is relatively strong.  By comparison, the ungeared nature of a BrickX investment would perform better in a higher interest rate environment with higher rental yields and lower capital growth.

Summary

BrickX is a very new platform and is currently only open to wholesale investments (e.g. SMSFs with $2.5m or more in assets or earnings over $250k per annum).  At the time of writing there are only three properties (2 Sydney, 1 Melbourne) listed as available for investment.  It is anticipated that as the platform grows it will open to retail investors and also have significantly more properties / bricks available.

The long term success and viability of the platform will be dependent on many factors, but scale will be important to get a suitable pool of investors that can provide the liquidity promoted.  The more investors they have buying and trading on their platform, the more revenue they will generate as their commission structure is 2% on every investor purchase.

BrickX will need to keep its costs under control – especially as it deals with the additional administrative, legal and regulatory costs when it moves into offering investments to the general public.  They will need to be innovative in this area.

Psychology is a major feature of traditional property investment.  Whether logical or not, Australians have an unusual lust for direct property investment.  Provided BrickX provides investors with a tangible connection to the underlying properties – i.e. ensuring the investments are NOT sterilised to such a degree they lose their appeal – then they should have some long term success.

We’ve seen significant innovation in the unlisted investment market in recent times. In addition to BrickX, we’ve got VentureCrowd for pre-IPO companies and also RateSetter for peer-to-peer lending. We might soon see a ‘master platform’ that leverages technology to enable investors (including SMSFs) to access a massive range of investments from direct property, to private equity and loans all alongside traditional Australian and international listed securities.

Important Disclaimer:

The information contained in this article is general in nature and is not intended to serve as advice. No warranty is given in relation to the accuracy or reliability of any information. Readers should not act or fail to act on the basis of information contained herein. Readers are encouraged to seek personalised advice from an appropriately qualified and licensed financial adviser for specific matters before making any decision.

Phone: 1300 889 282

Is a SMSF Right For You? | Superfund Partners

Kris Kitto

Director

kris.kitto@superfundpartners.com.au

 

Director at Superfund Partners. I love working in the SMSF space. Self-managed super funds are more than just a savings vehicle - they enable people to truly take control of their financial situation which is key to achieving happiness. Leading the Superfund Partners team is a privilege - they are a great crew and they always put others first.