Property  

In search of success

More recently, the development of unit-linked funds and property unit trusts have opened the asset class up to a wider pool of investors.

There are now also a number of listed real estate investment trusts. While Reits derive their long-term returns from investing in commercial property, in the short-term their returns often follow the pattern of the broader equity markets and hence offer a different risk/return profile to direct investments. Direct ownership of commercial property has historically demonstrated a number of distinct characteristics: High, stable income yield with the potential for growth through rental increases on UK commercial property has delivered a long-term total return of 10.7 per cent a year. The majority of that total return has been generated by income rather than capital growth. Since the majority of property rental income is contractual, it has proven resilient even in difficult economic conditions; in 2009, when dividends paid by the FTSE all share index companies were cut by 10.9 per cent, net rental income from property fell by just 1.2 per cent.

While property returns have exhibited a number of cycles and in particular suffered badly in the global financial crisis of 2007/2009, the long-term volatility of total returns has been lower than either gilts or equities. This has meant that the sharpe ratio, one measure of the reward generated from an asset class for the level of risk, has been stronger than both UK equities and gilts.

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One of the benefits investors gain from exposure to a range of asset classes is the smoothing effect on portfolio returns from the fact that asset classes are not perfectly correlated. Property has proven to be a good diversifier over the long-term; correlations to UK equities and gilts have been just 0.28 and 0.06 respectively.

One of the most distinct features is that as a unique, tangible asset, owners can implement strategies to add value to their investments through initiatives such as refurbishment, redevelopment and tenant mix repositioning.

While there is a strong case for including property in a diversified portfolio, there are several aspects that investors should reflect in their decision-making;

* Unlike assets that can be traded on the public markets in seconds, property assets can take several months to progress from the decision to purchase or sell to completing a transaction. While a number of funds and vehicles provide the ability to move into and out of property more quickly than that, investors should recognise property as a less liquid element of their portfolio.

* Given the relative complexity of property transactions and the taxes levied by the government, acquiring and disposing of property entails substantial costs. In my view, the lower liquidity and transaction costs argue in favour of allocating capital to property with a minimum expected holding period of five to seven years.

* Property portfolio management involves not just the selection of assets for purchase and sale but also the management of assets within the portfolio. This includes relationships with tenants as well as ensuring that assets are maintained in good physical condition. This makes it all the more important to select managers that have a strong investment performance track record.