Property Fund Investment – Constructing a DIY Property Debt Portfolio

In Australia, property investment has long been a favoured avenue for wealth accumulation. With a robust real estate market and a culture that values homeownership, many Australians seek to build their wealth through property. 

While traditional property investment often involves purchasing physical properties, a growing number of investors are turning to property debt as an alternative strategy.  Put simply, this involves investing in debt tied to real estate rather than directly purchasing properties. This approach offers several advantages, including diversification, liquidity, and potentially higher returns.

Just as prudent investors create investment portfolios diversified between different asset classes, so to, investors need to consider the investment mix of their property debt portfolios.  In this article, we give our top tips on constructing a DIY property debt portfolio. 

Planning is essential – Take time to understand the Market and calibrate your investment preferences and risk tolerance

Before diving in, it’s essential to research and understand the Australian real estate market. Familiarize yourself with different property types, locations, and market trends. This knowledge will help you make informed decisions when selecting property debt for your portfolio.

It is important, from the outset, to consider your total amount of investable wealth and the amount you wish to put into property debt versus other asset classes like cash and fixed income or listed equities.  I would strongly recommend investors to consider obtaining professional financial advice.

You should also carefully read product disclosure statements and other information issued by product issuers.  Real estate debt fund managers such as Corval Avenue are required to provide Target Market Determinations for each of their products and this is essential reading as it enables you to consider the risk / return profile, liquidity and investment timeframe and whether the product meets your objectives in terms of capital growth, capital preservation and / or income generation.

Diversify

As with any investment portfolio, diversification is key to managing risk. Spread your investments across different property debt investments to include different property types, geographical locations, and maturity profiles. By diversifying, you can reduce the impact of adverse events in any single segment of the real estate market.

Here I would particularly draw your attention to the maturity profile of your portfolio.  Property debt is generally considered an income product – loans usually pay monthly income and then return of the principal investment upon loan repayment.  Investors are exposed to interest rate risk and so it is important to have loans maturing at different times to ‘smooth’ the impact of any interest rate reductions on the income generated by your debt portfolio.  Investors have been lucky over the last two years as rates have been increasing, however, we are at or approaching the top of this rate cycle.

Assess Risk

Understand the risks associated with each debt investment in your portfolio. Different loan types have different levels of risks.

By way of example, two common real estate debt loan types are residual stock loans and construction loans.  A residual stock loan is made against already completed developments and enables the developer to move on to their next project by obtaining finance secured against the unsold lots.  The main risk for that type of loan is a failure to sell the remaining lots and that can be managed by extending the loan at a conservative loan-to-value ratio.

By contrast, a construction loan finances a developer who is yet to commence building the project and is an inherently riskier loan type.  Risks involved in construction loans include the builder falling into insolvency and being unable to complete the job, cost overruns, supply chain break-down and wet-weather delays.  All of these can cause the loan to extend beyond its maturity date.

There is a risk / reward trade-off involved as loans with heightened risks typically also pay a higher interest rate.  It is important, however, to fully appreciate the risks inherent in the loans so you can assess if the risk / reward trade-off aligns with your risk tolerance..

It is also important to understand risk features of the security property underlying a particular loan opportunity.  Key factors to consider include unzoned land, absence of development approvals and land prone to flooding or bushfires. While these factors do not necessarily disqualify a loan secured by such properties, it is essential to ensure the loan-to-value ratio is appropriate.

Monitor and Re-balance

Regularly monitor your property debt portfolio and review its performance. When capital is repaid from an investment, it presents an opportune time to rebalance your portfolio.

Constructing a DIY property debt portfolio requires careful planning, research, and ongoing management. By investing in debt tied to real estate, investors can access the benefits of property investment while enjoying increased flexibility and diversification.