Understanding property investments and building your fortune
As an asset class it took a battering after Brexit but there are a number of reasons why investors might consider property as part of a diversified portfolio over the long-term.
First of all, as a physical asset class it is not particularly correlated with stocks and shares or bonds so offers genuine diversification in terms of return.
In some quarters real estate is seen as a good hedge against inflation. It is a real bricks and mortar asset and – like gold or agricultural commodities – as such is expected to hold its value better than paper assets which typically see their value eroded by inflation.
Real estate offers the prospect of yield (from rental income) alongside capital gain and as such it has both equity and bond-like attributes. So the asset class also has relatively attractive fundamentals.
Commercial property can be split into three broad categories: offices, retail and industrial
The dynamics behind the residential property market in particular continue to be supported by government policy, in the form of Help to Buy, low mortgage rates and an ongoing imbalance between supply and demand, with the population of the UK expanding within the confines of a relatively small land mass.
For investors with limited capital, investing directly in property is tricky. Your own home should certainly not be considered an investment in the traditional sense though you do have the option of investing in, for example, a holiday home abroad or flat or house to rent in the UK.
As house prices often represent a large chunk of a lifetime salary most of these additional purchases will be made using buy-to-let mortgages.
Commercial property can be split into three broad categories: offices, retail and industrial. However, only extremely high net worth individuals can afford to invest directly. It would be difficult for ordinary investors to buy part of a tower block, for example.
Another issue with investing in property directly is a lack of diversification. Unless you are blessed with substantial amounts of capital then you are unlikely to be able to invest in more than one or two properties.
An investor in property has a choice of two classes: residential and commercial. Investment in the former is dominated by home ownership and the buy-to-let market. The big advantage of home ownership is that, for the designated main property, any gains are free of capital gains tax. Even allowing for this huge benefit most of us in terms of risk will be 'overweight' in residential property in our portfolios, either through circumstance or through choice.
Ways to play
The listed-contingent with exposure to the property market includes construction firms, house builders, property developers and landlords of commercial property. Holding shares in a property developer may not have the same effect as owning a house, but these companies will generate higher profits when house prices rise, which in turn will deliver higher dividends and capital growth. Real Estate Investment Trusts (REITs) are a relatively recent innovation, having been introduced in 2007. The Government has allowed these companies, which face extra regulation, a tax regime that almost replicates the situation you would face if holding property directly.
During spells of volatility property investment trusts and exchange traded funds (ETFs) are arguably at an advantage to traditional funds
The core business of REITs is protected from corporation tax, allowing the distribution of rent payments from their tenants to flow straight through to your dividend without being hit by extra levies. In theory a REIT should provide good levels of income as they are forced to pay out 90 per cent of the profits from their core business within one year, meaning a steady stream of dividends. A number of REITs feature in the FTSE 350 index: including British Land (BLND) and Land Securities (LAND).
Funds and investment trusts are popular with retail investors seeking exposure to a wide range of sectors and asset classes, and property is no different. You can find a rough list of property unit trusts on the website of the Association of Real Estate Funds. There are also a number of exchange traded funds which offer exposure to property.
During spells of volatility, like that seen in the wake of the EU referendum result, property investment trusts and exchange traded funds (ETFs) are arguably at an advantage to traditional funds because they do not expand or contract in size depending on fund inflows and outflows.
They therefore do not have to sell interests in properties to meet redemptions during periods of market panic.
Some of the more popular property ETFs include iShares UK Property (IUKP) and iShares Developed Markets Property Yield (IWDP).
Property fund exodus
Investors in property mutual funds, which invest directly in offices, shopping centres and warehouses, can only get their money out if the fund’s manager redeems their units. As a security measure such funds keep a cash cushion to meet demand from any investors wanting out.
But a spate of withdrawals in the immediate aftermath of the Brexit referendum eroded these cash buffers. Pre-Brexit Standard Life’s reserves were 13 per cent of its £2.9 billion commercial property fund’s value, yet it is one of seven fund managers which suspended trading as it could no longer meet redemption requests. After all, unlike stocks and shares, big office blocks cannot be sold at the click of a button.
These suspensions are built into the funds’ structures and are not the first time they have been enforced. During the financial crisis some were also suspended for a period.
Suspending trading is not the only option for managers looking to deter investors from withdrawing their cash. They could increase the exit fee. This is what Aberdeen UK Property (GB00BTLX1G31) did. Investors now have to pay a 17 per cent penalty for taking their cash out of that commercial property fund. Management has essentially written down the value of its portfolio by almost a fifth. Legal & General (LGEN) followed the same path for its UK Property fund.