The idea of carving up large assets into fractional investment units is gathering momentum. From investing in small parcels of shares through platforms like Stake, to property crowdfunding solutions like DomaCom or BrickX, fractionalisation has opened the door to new opportunities.
And this has significant implications for strategic asset allocation. Advances in automation, artificial intelligence and the internet of things are opening up access to what were traditionally considered ‘private market’ investments.
For investors, allocating funds to private debt as an asset class means you are effectively acting as the bank. Like any lender, they get return on capital in the form of monthly interest payments made by borrowers.
ALTERNATIVE TO PROPERTY FUNDS
With expectations Australia’s residential property prices will lift as much as 18.5% in 2021, pent-up domestic investment demand has fuelled a red-hot property market. And property has long been seen as a “safe as houses” investment in Australia, underpinning 51% of household wealth, according to 2018 Australian Bureau of Statistics data.
But there are downsides to investing directly in property. It’s capital-intensive, and hard to diversify your asset allocation across retail, commercial and residential assets to mitigate the impact of property cycles. It can also be hard to get a decent rental yield in a heated market, as purchase price growth outstrips rent rises – in July 2021, gross rent yields were just 3.4% nationwide.
And of course it’s also not the most liquid of assets – if investors need to release cash quickly, settlement alone can take at least six weeks and you’ll incur high transaction costs in the process.
Fractional investments in property can address some of this issues – but until recently, real estate investment trusts (REITs) and property funds were the only real options to do this.
REITs have certainly proven a popular option for investors searching for yield in a low interest rate market. Inflows into unlisted Australian property funds increased 28% in the first three months of 2021, compared to the previous quarter. With over $676 million in net inflows, it’s clear the yield differential over other forms of fixed income or cash has made a compelling argument.
However, investing in private real-estate debt can provide a similar advantage – with the potential for attractive returns.
For example, a new growth fund tapping into rental yields from residential properties is targeting returns of between 3% and 4.45% per annum. AltX investors, while not participating in capital appreciation, receive stable returns of between 4% and 8%.
Private debt investors get the benefit of an investment backed by real estate security, with a predictable monthly return. They can start with a single investment or build a diversified portfolio based on available capital and risk profile.
DEMOCRATISING ACCESS TO INSTO-SIZED INVESTMENTS
Tech platforms have changed the game in two ways: fractionalisation and distribution.
It was not that long ago that private investing began and ended with the stockmarket. Investors could quite easily buy a diversified portfolio of listed equities, but not much more. Unlisted investment opportunities were reserved for a privileged few – primarily institutional investors with large cheque books and multi-billion dollar investment portfolios.
At the smaller end of town, access to private syndicated investments was based on networks and by invitation only. This meant both sides of the market were missing out: demand for capital was inefficiently matched to limited pockets of supply – think ultra-high net worths and family offices. At the same time, investors with capital to put to work were lost on how to access quality opportunities.
Access to fractional investing is disrupting that traditional status quo by harnessing the power of digital platforms for distribution. By breaking unlisted investments up into smaller bundles, a much larger universe of investors suddenly has the cheque size to play. And, by seamlessly distributing offerings via platform to thousands of investors at the same time, everyone can participate on an equal footing.
Previously, a private offering might have been taken up by a small number of private investors who personally knew the primary deal sponsor. A private club, if you like. Now bite-sized chunks are open to an infinitely larger investing universe. A farmer in Wagga or a retiree on the Sunshine Coast – they all now have the same access to opportunities as the networked set in Sydney and Melbourne.
This larger pool of investors will continue to grow when our platform is able to open up to retail investors, beyond its existing pool of wholesale investors.
A new generation of investors is already attracted by the accessibility and affordability of fractional investments. BrickX, for example, operates as a ‘stock exchange’ for fractional residential real estate investment, with a minimum investment of just $250 in units (or ‘bricks’) and the BrickX property trust. Most of its investors are aged under 35. And fintechs like Stake, which enables Wall St share trading in minutes on a mobile app, are meeting the needs of this next generation of investors. Australian-owned
Stake recently announced self-managed superannuation fund (SMSF) set-up and administration services, and has already launched in New Zealand, the UK and Brazil.
MORE CHOICE FOR FINANCIAL ADVICE
For financial advisers, this democratisation of investment may seem like a double-edged sword – it gives their client direct access to an ever-increasing range of opportunities.
However, it’s also a significant opportunity to help clients make smarter decisions, reallocate funds for improved portfolio diversification, and access real-time reporting to help clients understand exactly what they’re investing in.
With the 10-year yield on Australian Government Bonds just 1.57%, and the official cash rate inching closer to negative returns, private real estate debt rates of 4% to 8% look pretty attractive. And as the deals are typically short-term – on average 12 to 18 months – they make a solid alternative for investors who cannot achieve target income with fixed income investments, including SMSFs.
These returns also make private debt more attractive to older clients who prioritise a reliable income stream in retirement.
Age, it seems, is no barrier to fintech adoption. A sizable portion of our investor base are retirees who access the tech platform daily to invest in property-backed deals. This generation of investors is more comfortable than you may think about using a platform to access investments, and this is tremendously encouraging – it shows the path to investing via platforms is becoming mainstream.
For financial advisers, it’s another sign that client expectations have shifted – demanding greater transparency, accessibility and control. Instead of seeing that as a threat, it can become an advantage.
Because the real beauty of this model is the way it connects investors with opportunities they might otherwise not have known existed. And as it is secured by registered first mortgage, there is tangible asset backing.
Re-thinking the asset allocation mix
Fractional investments change the game in terms of risk and return, so it’s worth thinking about what this does to the target portfolio mix.
As a fractional owner, investors have a smaller capital outlay, improved diversification and the benefit of detailed due-diligence. For example, at AltX, we get a 360-degree view of the true valuation of the asset underpinning a private debt deal. Clients tells us they look at the LVR (Loan to Value Ratio) to assess risk. They appreciate the transparency – they know exactly where their investment is going, where the underlying security asset is, and who they are dealing with.
If you are new to private debt investing, there are a few things to consider. Check how the risk is isolated for example, AltX uses separate special purpose vehicles (SPVs), so deals are ringfenced from each other. Make sure you have access to the underlying documentation, and know your rights in the event of a default. And check the interests of the people managing the loan align with yours – are they also willing to invest on the same terms?
As technology continues to advance, investors will have access to more options than ever before. However, the fundamentals of investing remain the same: know your risk profile, do your homework on who’s behind the deal, and diversify your portfolio to mitigate downside risks.
Nick Raphaely is co-founder and co-chief executive at AltX.