Your IndustryAug 11 2016

Going global or recommending residential

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Going global or recommending residential

Real estate investment trusts and UK commercial property funds are most common routes for retail clients but there are other ways to put property into a portfolio.

These include using global property funds - which can be either non-Ucits retail schemes (Nurs), or qualified investor schemes (QIS), and even direct in property.

Residential property is also an option - not buy-to-let, which is covered in a previous guide but residential property funds available to UK investors.

Global property funds

Diversification is the mantra of most investment professionals, and property is no exception, says Rob Gleeson, head of research for FE.

“Global property is our preferred route in property investing. The UK commercial property market is quite concentrated and prone to sentiment, so it has a large specific risk which could be diluted greatly by diversifying into other regions”, he said.

Some fund groups invest directly in global property; others invest in listed property companies, such as the L&G Global Property Dividend Index fund.

Funds which have adopted the PAIF tax structure will allow tax-exempt investors such as Isa holders to receive income distributions gross of corporation tax Adrian Gaspar

Global property funds investing in underlying real estate securities include:

■ £279m HSBC Open Global Property

■ £295 Old Mutual Global Property Securities

■ BlackRock’s £1.1bn Global Property Securities

■ The newly renamed £654m Schroder Global Real Estate Securities fund, which is now called the Schroder Global Cities Real Estate fund.

In its letter to investors of 1 August, Schroders stated: “Global cities are hubs for economic growth and development, and funds which invest in real estate securities that own properties in successful urban centres worldwide will perform better than those which lack this exposure.”

Tom Dorey, head of global real estate product for Schroders, says: “Data suggests by blending direct domestic and global real estate securities, investors could achieve good risk adjusted returns.

“In addition, global exposure avoids the macro risk associated with investments in a single country – the EU referendum being the latest example of this.”

Concentration

It is best for clients to not look for country-specific funds to avoid concentration risk, although as Ben Willis, head of research for Whitechurch Financial Consultants says, there are other pitfalls.

He says: “Overseas property is very different to UK bricks and mortar. For example, investors wanting to get into the US can only invest in US Reits - with the associated equity risk - because of taxation.

“Additionally”, he warns, direct property funds based overseas bring other costs. He explains: “There is double taxation and currency treatment to take into consideration when investing in global property funds that invest directly in property, which would add to the running costs.

“Some equity risk and added currency fluctuation would push up the risk profile on overseas property funds.”

For the average investor looking to go global, Mr Gleeson recommends clients look for a fund of funds approach.

He says: “The challenge is that it is difficult to analyse all global property markets, so the common approach is to invest in a fund of funds.

“This structure also aids with liquidity, as one stressed market will not see the entire portfolio frozen.”

However, fund of funds can sometimes add an extra layer of fees, something advisers should explain to clients.

It is also difficult to compare property fund performance and risk metrics against peers in the Investment Association Property sector, because the 44-fund strong sector contains domestic and global funds, property fund-of-funds, and property funds investing in listed companies.

Areas of interest

Where are property hotspots overseas where investors in global funds can potentially get good long-term returns?

According to Schroders’ Global Cities 30 index, Shangahi is the top global city, followed by New York. London had been fourth but post-Brexit vote, it has slipped to 10.

For investors seeking a globally diversified residential property portfolio, Australia and Germany offer good prospects for capital appreciation and yields.

Elizabeth Chu, head of investment for IP Global, says: “The UK is bread and butter for us but we have investors interested in Australia, which has low interest rates, good population growth, lots of infrastructure investment and a good currency play.

“Asian investors and Middle East clients have liked the similarities of Australia to the UK’s system, such as the language, tax structure and regulatory environment.”

Hamish Pound, senior investment manager for IP Global, says: “Berlin is the most exciting city for our clients to invest in. During the second half of 2015, prices rose significantly and we see growth increasing due to lack of supply and high demand.

“What our clients are looking for is capital appreciation and a good yield, and Berlin offers this, with approximately 5 per cent annual yield in residential property.”

For investors wanting more diversification, Ms Chu says: “One of the most interesting cities is Tokyo. During the 1990s there was a huge depression there but we are now seeing wage growth and house price growth - not to the same extent as in Berlin - but there is opportunity there.

“Also, the Yen offers some global currency diversification under the one portfolio.”

However, both managers expressed there can be language barriers, different legal and tax restrictions, so it is important for the average UK investor to make sure they have expert advice from people who have the insight to perform due diligence on these markets.

Ms Chu says: “People see London as a safe haven, but we also consider New York and Sydney, Australia. Some people might prefer to pay a slightly higher price in exchange for more stability.”

According to Mr Pound, while returns from property might look fantastic in China or India, risk is a significant factor to consider.

Risks of going global include:

■ Political

■ Development

■ Country and population

■ Geographical risk

■ Currency risk - for example, the possibility of the Renmimbi going down.

Mr Pound adds: “Risk within a global portfolio is vital to mitigate as much as possible while being able to generate returns for clients from around the world.”

Residential Property funds

Residential property funds are rarer beasts, but there are some available, such as the £50m TM Hearthstone UK Residential Property fund, structured as a Property Authorised Investment Fund (PAIF).

There tends to be less of a liquidity issue, given the property sizes are smaller on average than individual commercial property sizes.

According to Adrian Lowcock, investment director for Architas: “Residential property funds give exposure to areas of growth in the residential property market, particularly rents and student lets.

“These are being run as a business in their own right and ofer exposure to unique parts of the UK economy.

“Investors often consider it a way to get property price rises before they can afford to buy residential property outright.”

Adrian Gaspar, multi-asset investment specialist for Prudential Portfolio Management Group, says: “A well-run residential fund should have a high occupancy rate of 97 per cent or more.

“There is a well-publicised imbalance between supply and demand for residential property and those funds which have adopted the property authorised investment funds (PAIF) tax structure will give tax-exempt investors such as pension schemes and Isa holders the opportunity to receive income distributions gross of corporation tax.”

Further, there is growth in the market.

Figures from the 2015 Property Industry Alliance paper, called the Property Data Report, revealed the growth of residential property has far outstripped new commercial developments.

The report states the stock of commercial property represents 10 per cent of national net wealth. Privately rented residential property accounts for a further 12 per cent of the UK’s net wealth.

The size of the residential market is much larger, therefore, by comparison.

However, despite the market being deep, there are disadvantages to residential property investment, as Mr Lowcock explains: “The chances of a fund replicating property prices in a specific are limited so it won’t necessarily help with saving for a deposit.

“Also, as a sector it is still evolving and the bigger residential projects have mixed results, with some big failures.”

Way ahead of the Brexit vote, two major residential investment companies - British Land and Land Securities - registered losses of 8 per cent in the week commencing 8 February and 15 per cent over the year to 12 February respectively.

Moreover, it doesn’t necessarily provide enough diversification, particularly for those who already own their own homes.

Also, fees can be high. According to FE’s Mr Gleeson, residential returns have not been as peachy as those of commercial property so fees can really erode returns for investors.

He says: “The extra administration burden of managing a large number of properties can make them expensive. The average ongoing charges figure of a commercial property fund is 1.1 per cent, whereas residential property funds average around 2 per cent.”

Mr Gaspar says: “Residential can offer a lower net yield than commercial property, as property management costs are borne by the fund, and hence deducted from rental income.”

Also, because it is often a poorly researched asset class, Mr Gaspar says not all investors understand how a residential property fund works, or the diversity of assets in the sector.

He states another disadvantage: “Paifs are not all listed on several of the large platforms, so investors can only access authorised property unit trusts, which are subject to 20 per cent corporation tax”.

Unregulated property schemes

There are opportunities for investors to take a ‘tranche’ in a particular development, such as a hotel, warehouse, retail park or other venture, either in the UK or overseas.

These tend to be unregulated schemes and suitable only for sophisticated investors who can afford to wrap up their money - often for £25,000 or £40,000 minimum investment - for a set period of time.

Many such property investments have been used within self-invested personal pensions (Sipps).

However, while these can sometimes be useful for long-term financial planning for wealthy investors, the fact these are unregulated and tie up investors’ money for a set period of time - not to mention the fact some of these are ‘development stage’ properties, not finished and pre-let - should set alarm bells ringing.

Such schemes have already caused concern for the Financial Conduct Authority and European regulators over holiday home developments in Bulgaria or hotels overseas which have not come to fruition.

Therefore, it is understandable why the FCA sets high store on how advisers assess suitability for investors, as its unregulated collective investment schemes (Ucis) factsheet for advisers shows.

Moreover, the Financial Ombudsman Service has seen its fair share of such property schemes collapse around investors’ ears, such as the following case whereby a pensioner had unwittingly invested into commercial property within Ucis.

Fos case study 125/13

Mr W had recently retired and after selling part of his business, had a lump sum he wanted to invest.

During a meeting, his financial adviser recommended some funds she said she’d recently invested in herself – both commercial property investments. So Mr W invested a total of £400,000 across the two funds.

From his yearly statements, Mr W noticed the value of the funds had been gradually declining. When he looked into the funds in more detail, he found they were part of a Ucis.

Mr W complained to the adviser – saying he hadn’t known he’d invested so much in Ucis, and felt his money was at risk. But the adviser said the funds were suitable for Mr W because he’d been classified as a “speculative” and “sophisticated” investor. So they didn’t agree with his complaint.