The other attraction to investing in residential property is the low correlation to equities and other assets. Mercer’s Lee says his data shows that a well-diversified portfolio across every capital city in Australia would provide a “reasonable” level of volatility and correlation to other asset classes.

Residential property beta is based on Australia’s house price index, which in the long term has averaged around a 6 to 7 percent increase each year. Lee thinks a good manager could get a low double-digit return from “capturing the upside” of house price appreciation through the terms of their EFM contracts. Alpha would be achieved through superior selection of customers, Lee says.

In Defence of direct res property

Direct investment in residential property is available to institutions through a handful of funds, such as the Westpac Residential Property Trust, an unlisted pool of currently 441 houses throughout Australia. The houses are residential properties let to Defence Housing on a longterm lease. Lance Vassarotti, who designed the fund, says the trust offers the scale and diversity needed to get adequate exposure to this asset class.

Partnering with Defence Housing helps manage the administrative aspects of the portfolio. “One of the impediments to this market is you need scale and you need diversity, but with scale and diversity comes problems managing the portfolio, so Defence are great partners with us because they manage this otherwise difficult portfolio scattered all around the country,” Vassorotti says.

Defence Housing looks after the tenancy issues at a local level. It is also the official tenant, so there is no vacancy risk for the period of the lease. Buying units in the trust gives the investor exposure to both the rental income and the capital growth of the underlying assets. Defence Housing is still Westpac’s lone partner since the property trust opened in June 2006, but Vassarotti says the plan is to expand with more partners. “Defence is only one platform of the trust. We’re in discussions with a number of other parties for other residential property assets, so over time Defence will only be one part of a much larger residential property trust,” he says.

The trust is currently being valued, however the last valuation in June 2007 tipped it to have around $226 million of assets.