THE PROS AND CONS OF PROPERTY IN MULTI-ASSET INVESTING
Some investors extol the merits of property as a way of building wealth, but property investment comes in a variety of forms with different risk and reward characteristics. Understanding these is vital when considering the potential role of property in a multi-asset portfolio.
The late US real estate investor Louis Glickman, who owned swathes of uptown Manhattan, said: “The best investment on earth is earth.”
But property investment is far from a one-way bet. The property sector is not immune from macro-economic developments and cyclical ups and downs, both in terms of capital appreciation and rental income – so, as with all asset classes, there are pros and cons associated with property investment.
THE LATE US REAL ESTATE INVESTOR LOUIS GLICKMAN, WHO OWNED SWATHES OF UPTOWN MANHATTAN, SAID: “THE BEST INVESTMENT ON EARTH IS EARTH.”
WHY INVEST IN PROPERTY?
Property (or real estate as it is also known) offers potential for attractive long-term growth and can help increase diversification within a multi-asset portfolio.
It could also be viewed as an alternative, or complement, to fixed income within a multi-asset portfolio to potentially reduce volatility. Besides offering potentially attractive long-term returns, property is less vulnerable to interest rate risk than traditional fixed income investments, as it is a ‘real’ asset. Also, as rent reviews tend to be upwards and some rental agreements are inflation-linked, property can provide a degree of protection from inflation.
There are several ways of investing in property. While pension funds can own individual buildings directly, it is arguably more efficient and less risky for smaller funds to invest directly in specialist property funds that own parcels of real estate or to invest indirectly through specialist funds that invest in publicly listed property companies. Both options can help spread risk. Diversification can be achieved either via choice of building type or via geographic diversification, either of properties or listed property companies.
DIRECT PROPERTY INVESTMENT
Direct property funds invest in physical property such as shops, offices and warehouses. They aim to make a profit from rental yield as well as capital appreciation. This can be an attractive option, but the downside is that managers may have significant challenges with fund liquidity, if sentiment changes on the sector. This happened in the wake of the EU referendum in 2016, leading to substantial outflows from open-ended UK property funds. This led to several open-ended funds having to announce suspensions for a period of time, protecting the interests of existing investors and allowing liquidity to be restored. The Financial Conduct Authority (FCA) is currently monitoring UK property funds following acceleration in fund outflows.
INDIRECT PROPERTY INVESTMENT
This can be done via funds that invest in listed property entities, most commonly REITS
(Real Estate Investment Trusts). REITS are well-established tax-efficient listed property
investment vehicles, first introduced in the United States in 1960. They were
introduced in the UK in 2007, with the bulk of large listed property companies
converting to REITS. Today more than 30 countries have REITS.
REITS own and manage property with the aim of generating a rental income, the bulk of which is distributed to shareholders in dividends. They provide an opportunity to
access and own property assets without having to buy physical property assets. A REIT
will typically spread investment over several properties, therefore investors are not
reliant on a single property for returns.
The principal risk to REITs is equity market volatility, as REITS are unlikely to be insulated from broad-based equity price falls in volatile trading, at least in the short
Another potential risk is poor debt management. As REITS have to distribute the bulkof rental income to investors, new properties or acquisitions are largely debt-funded, so responsible borrowing and debt management is critical.
Finally, REITS are exposed to underlying commercial real estate trends. If investor and indeed occupier sentiment declines, causing falls in capital values and rental income, then this is likely to have a negative impact on REITs too.
Some argue that property shares offer limited diversification as they are just an equities subset. However, our own analysis, supported by numerous studies, concluded that although in the short term listed property shares are more correlated to equity markets, in the longer term they are more correlated to movements in underlying property markets, therefore can offer diversification.
HOW WE INVEST IN PROPERTY
Our default multi-asset Pension Portfolios do not invest in property – they achieve relatively low-cost multi-asset diversification through a blend of equity and bond investments.
Our Premier Pension Portfolios, meanwhile, invest in both direct and indirect property (with the exception of Premier Portfolios 1 and 5).
Our analysis indicated that this blend is a cost-effective way of achieving diversification benefits and investment returns from exposure to commercial property.
We believe that investing in UK property directly, plus an allocation to global property markets, has the potential to offer greater diversification via exposure to different property market cycles, country dynamics and sector exposure.
For direct investment, Premier invests in the Scottish Widows Pooled Property ACS Fund 1, an actively managed direct property fund that invests in physical property such as shops, offices and warehouses.
For indirect property investment we use the BlackRock Global Property Securities Equity Tracker Fund, which offers cost-effective access to a well-diversified liquid portfolio of the largest property REIT securities in the world. It is invested in REITS that own a mix of property types with assets in the United States, Asia, Continental Europe and the UK.