A property investment breakthrough?

‘Fractional Property’ offers to crack a perennial conundrum facing residential property investors …how to buy a ‘piece of property’ without dealing in A-REITs.

Summary: As SMSF interest in residential property grows, a new managed investment scheme, DomaCom, was launched last month and aims to allow investors to avoid the concentration risk of direct property investment.
Key take-out: A new property investment offering DomaCom has potential, but its liquidity is still unproven.

Key Beneficiaries: SMSF trustees and superannuation accountholders. Category: Superannuation.

Property and borrowing are highly contentious topics. They are on the radar of regulators and the focus of skepticism from traditional parts of the financial community. Driven by widespread investor fear of the travails of the sharemarket and the apparent attraction of “bricks and mortar,” SMSF direct investment into residential property is on the rise (albeit still at relatively low levels compared to other asset classes). For the normal SMSF with a median fund size of $500,000, direct property may be an attractive idea but brings with it “concentration risk” – since even a modest residential investment property may cost upwards of $250,000, buying poorly will expose a significant portion of the SMSF to risk of loss.

The new DomaCom “fractional property” facility seeks to overcome these problems and if it gets the traction that its founders expect, it should be a very powerful new entrant to the Australian market (www.domacom.com.au).

The DomaCom idea is relatively simple, and has the potential to be a powerful disruptor to our financial services marketplace. DomaCom is the combination of:

• an ASIC registered managed investment scheme which buys residential investment properties and issues units to investors, entitling them to share in the income and capital growth of the underlying properties;

• a web based search engine and investor “matching” facility, allowing investors to select and bid on a “fractional interest” in one or more investment properties, and also allowing them to offer to sell some or all of their “fractional interests” to other incoming investors should they wish to sell down or rebalance their portfolio.

So rather than forcing a “normal” SMSF to use debt to reduce its upfront capital outlay if it decides to buy an investment property – currently the only practical way to allow the SMSF to also hold a meaningful exposure to other assets so as to maintain portfolio diversification – the DomaCom facility has the potential to be a viable solution to a very real investor need. Like all investments, the detail of how and what you buy is key to understanding the real risks. 

DomaCom set up as a managed investment scheme

As a result of current investment regulation, DomaCom is forced to use the “managed investment scheme” (“MIS”) format. This certainly does provide a very high level of investor protection, with Perpetual Trustees providing the key services of “Responsible Entity” for the MIS as well as holding each property in custody for the benefit of investors. DomaCom provides the search engine which investors use to select properties to buy and sell – and once a property is purchased by the DomaCom MIS, the title to that property and the rental income it receives are held separately from the assets of DomaCom.

One of the problems with the MIS approach is that it is a very costly and complex arrangement to create and manage. Ideally each property would be held within its own MIS, but the high cost of maintaining individual MIS means that the DomaCom facility utilizes the not uncommon idea of creating separate classes of units (each linked to a “sub-fund” underneath the one, master MIS).

DomaCom provides a market making and “bookbuild” facility whereby prospective investors can bid for a fractional interest in a property/properties that are displayed on its search engine. The minimum investment amount is $20,000 which is placed into an ANZ cash account pending finalisation of the purchase of the underlying property. Once a property is purchased it is held by the DomaCom MIS, and the investors which are linked to that property are issued units entitling them to a fractional interest in the property held by their sub trust.

During the term of the investment, the rent from the property is paid to each unit holder after deduction of fees and property management costs (pro rated to their fractional entitlement), and on the sale of the property the proceeds of sale are distributed to each investor in their respective proportions.

The “default” is that each sub-trust will be terminated at the end of 15 years from establishment. Investor liquidity prior to the termination of each sub trust is intended to be via the search engine and market-making facility provided by DomaCom – the intention being to create a liquid market where existing and new investors can trade their units freely. Time will tell if this liquidity does actually occur – and here is where the distribution plans underway will help DomaCom kick start this new facility.

The DomaCom platform was soft launched at last month’s SPAA Conference – the annual event for advisers servicing the SMSF sector. Direct SMSF marketing is about to begin – and the ambitious plans of DomaCom founder, an IT and investment technology specialist, Arthur Naoumadis will start to be tested.

Apart from the as yet unproven liquidity which will be needed to allow investors to buy and sell at will, the other main drawback lies in the use of the sub trust mechanism – this effectively means that claims against the DomaCom MIS made by one investor could end up allowing them to access the assets of all other DomaCom investors. In practice this risk is likely to be relatively small – professional property management including property insurance means the risk of unexpected financial loss should be remote – but this is a direct consequence of current MIS laws.

DomaCom fees are 0.8% pa which compares well with other “alternative” investments – and should be seen as the price for the control which the DomaCom facility provides. Compared to buying into one residential property which creates high levels of concentration risk, or using gearing to reduce upfront capital outlays, DomaCom has the potential to liberate all SMSFs and allow them to use property as part of a well diversified portfolio. Australian investors will no doubt watch the unfolding DomaCom story with interest.

Tony Rumble is the founder of the ASX-listed products course LPAC Online, a provider of investment training to financial services professionals. He provides asset consulting and financial product services but does not receive any benefit in relation to the product reviewed. Twitter: @TonyRumble.

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