By Saskia Georgeson-Rowles
Historically, Performance Property has mainly adopted a growth strategy in our property portfolios, targeting quality assets in the value stage of the property cycle. This strategy has been highly successful over the last 10 years and generated large amounts of equity for our clients.
As we move into the next phase of the property cycle in Australia, Performance Property is focusing on balancing our clients’ property portfolios with higher income producing assets. To achieve this we meet with our clients annually and review a number of statistics which include:
- Debt-to-Income ratios
- Cash Buffers
- Net Yields
- Loan-to-Value ratios.
For clients looking to balance their portfolio, we may be recommending releasing equity or selling property in locations that are near or at the top of their property cycle, and reinvesting in assets that have a higher yield profile.
One potential high yielding asset that we have been investigating is Specialist Disability Accommodation (SDA).
What is Specialist Disability Accommodation?
SDA is housing that is provided for people with high support needs or extreme functional impairment. It is funded through the National Disability Insurance Scheme (NDIS); a government agency that provides Australians living with a disability with funding, information, and access to necessary services in their community.
SDA must be built to meet NDIS criteria, which makes the capital costs of this type of project significantly higher than a mainstream residential investment. This may involve inclusions such as wider corridors, adjustable benches, and accessible bathrooms.
The government incentivises private industry and individuals into SDA by returning a rental yield above market expectations. Our research suggests that a net yield of 6 - 8% can be achieved through SDA, in comparison to a quality residential investment that will return a net yield of 1.5 - 2% in a capital city or 2 - 3% in a regional area.
Specialist Disability Accommodation Investment Risks
Upon reviewing the SDA program in detail, we have identified five key risks:
- Vacancy risk
- Construction risk
- Valuation risk
- Funding risk
- Liquidity Risk
SDA properties must be leased through a registered NDIS service provider. A lease cannot be signed prior to the commencement of the build, which is a critical issue as a specialised property is being built without the security of a tenant commitment.
Reliable NDIS providers estimate that the overall vacancy rate sits around 20%, however vacancy rates can range from 0 - 40%. This is a multifaceted problem which is impacted by factors including the generic oversupply of average quality or not fit for purpose SDA, as well as a lack of tenants, carers and/or service providers in a specific area.
The vacancy rates of high quality builds in excellent locations is relatively low, with most unoccupied properties being of low quality where the investor has executed a bare-minimum build in order to meet NDIS requirements.
Quality SDA cannot readily be purchased on the open market, so in order to participate in this strategy, you will need to engage in a development which brings about construction risk. In a typical market, we rate the construction risk on a project as moderate to high. However, with the post-covid supply and pricing issues facing the construction industry, evidenced by several large national and local builders facing insolvency and going into administration, the construction risk is significant.
Your ability to settle can also be impacted due to valuation risks. At the moment there are very few lenders who understand and are willing to lend in this space. What we are finding is valuers are not taking into account the specialised nature of these properties and as such are valuing them as normal residential property. This results in properties coming in under valuation by 10% - 30%.
The valuation risk can lead to financiers requiring a lower Loan-to-Value ratio (LVR), in some cases around 60% which is comparable to financing a commercial property. The balance between the sale price and the valuation or approved LVR must be funded by cash.
There are also general risks with funding when committing to a project now, with settlement being 12 - 24 months away, such as changes to interest rates, changes to property market conditions and changes to your personal income. Particularly with interest rates on the rise, market risks can impact your ability to settle or qualify for your loan.
When selling a property, you want to make sure there is a large enough pool of buyers willing and able to purchase the property. That is why we always consider the exit strategy when looking at an investment acquisition.
There is a reduced market of buyers looking to purchase SDA assets. They will not be appealing for all investors as they are more complicated to understand and finance, and therefore harder to sell.
SDA investments are far less liquid than standard residential investment properties that appeal to owner occupiers. As the market for purchasing pre-built SDA is limited, the exit strategy will likely need to include construction costs for remodelling the property to make it appealing to the mass market before a sale can occur.
Specialist Disability Accommodation Investment Benefits
While the risks listed above have prevented Performance Property from taking a position in SDA investments for our clients right now, there are some benefits that make this an attractive investment for some people if they can overcome these risks. These benefits include:
- Tenants aim to find life-long accommodation. Once settled in a property, they will sign leases of 5 - 20 years,
- Significantly higher net yield than a residential investment if there is low vacancy,
- SDA payments are made by the government directly to the service provider, reducing the risk of rental arrears,
- This could be a better option for investors with budgets below $1m to access a defensive high yielding asset without having to purchase a poor quality commercial asset.
At Performance Property, we are of the view that the current risks involved with setting up a SDA investment are too high for us to engage with or to recommend to our clients. We will continue to workshop innovative ways to minimise the risks that come with SDA, as well as evaluate other income-producing options in order to deliver balanced property portfolios for our clients.
This article is intended as general information only.
The article includes economic and market commentaries based on proprietary research, which are for general information only. The author believes the information contained in this article to be reliable, however its accuracy, reliability or completeness is not guaranteed. Any opinions or forecasts reflect the judgement and assumptions of the author on the basis of information as at the date of publication and may later change without notice. Past performance is not a reliable indicator of future results.
Any advice in this article is general in nature only and does not take into account your personal objectives, financial situations or needs. Before making any investment based decision, carefully consider the appropriateness of the advice in light of your financial circumstances and seek independent personal financial, legal and tax advice.
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