Why Would You Invest in Property?
With interest rates at historically low levels, property has recently gained in popularity. Indeed, one of the benefits of the asset class is the regular cash-flow generated by collecting rents, similar to the coupon payments received from bond holdings. A property investment not only provides the potential for capital appreciation but is also considered to act as at least a partial hedge against inflation. Property can also be used to diversify a portfolio; that said, not all property funds will provide a diversification benefit to the same extent.
Mutual funds can invest in direct (unlisted) property and indirect (listed) property securities. The former is bricks and mortar, i.e. investing in direct property means buying a building, while the latter is an investment in the shares in REITs (real estate investment trusts) and other property companies. Investing in property indirectly can be a more liquid method of investment, but it is also more highly correlated with traditional listed equities and thus indirect property investments will act in a similar manner to equity markets. If you’re interested in property’s diversification benefits, an indirect investment might not therefore be the best way.
How To Access Direct Property?
If you own your home, then you are already directly invested in property. But this means your assets are tied up in residential property. Commercial property such as office space and retail outlets can provide further diversification. The easiest way to get exposure to a broader remit of direct property—without buying up shopping malls—is via mutual funds. Both open-end and closed-end funds that invest in direct property are available and both vehicles will have some characteristics that work for and against them.
As real estate is indivisible, the unit value is significantly higher than stocks and bonds, i.e. one company share might cost you £1 but one commercial property could cost £10 million. For open-end funds, this means that the managers have to hold high levels of cash to cover potential redemptions, so investors should be aware that they’re not always getting as much property exposure as they might expect. What’s more, even high levels of cash can’t guarantee against unconstrained withdrawals. Indeed, when the financial crisis hit in 2008, many open-end direct property funds gated investors and refused redemptions for several months.
One could argue that the closed-end fund structure is no better, as discounts widened significantly during the financial crisis. A key difference here, however, is that shareholders of investment trusts and other closed-end funds providing exposure to direct property were able to action their desire to sell their shares and get their money back, even if it wasn’t the amount they had hoped for. At the end of 2008, the average direct property investment trust was trading at a discount of more than 60% to its NAV (as of January 1, 2008 the average discount was around 25%), but shareholders could choose whether to accept the prevailing price or to wait for the discount to narrow.
The closed-end structure does have notable benefits when it comes to investing in direct property. The managers of these funds do not have to deal with money flowing in and out—as the structure is closed—so portfolios can be more fully invested, with less of a cash drag. That’s not to say they won’t hold cash too, for future investments, but there’s no need to keep that buffer to fund redemptions. The fact that closed-end funds trade on a stock exchange also means the shares can be sold anytime, assuming of course there is a willing buyer. Granted, the price one can get might not be close to NAV.
If you’re interested in using investment trusts to gain exposure to direct property, there are 62 such trusts available on the London Stock Exchange. UK Commercial Property (UKCM) and F&C Commercial Property (FCPT) are among the largest. Both funds invest in prime UK commercial property. The former has been run by Robert Boag since December 2010 and the latter by Richard Kirby since March 2005. Another well-known name is Schroder Real Estate Invest (SREI) run by the Schroder Property team.
Conclusions
Property is an important asset class with some key characteristics that can benefit a portfolio, namely income and diversification, but you need to know what you’re looking for and why before making an investment. Direct and indirect property provide different benefits and there are different ways to access them, so before making the final decision, make sure you know what you are getting.
