Property exposure through closed-ended funds

Reits and other closed-ended funds are listed companies that make property investments.

Instead of holding a share of the underlying holdings, investors own stock in the Reit, which can get round the liquidity issue as the shares are traded on an exchange.

Annabel Brodie-Smith, communications director of the Association of Investment Companies (AIC), says: “Reits and other closed-ended property funds are an alternative to property open-ended funds.

“The closed-ended structure comes into its own over the long-term when investors can sit out the inevitable economic wobbles and their impact on the commercial property sector.

“Investment company managers do not have to worry about inflows of hot money and outflows when times are tough and buyers are hard to find, but can concentrate solely on the long-term performance of the portfolio.”

According to Russ Mould, investment director at pensions specialist AJ Bell, pension investors in particular might be wise to seek advice on whether to add property investment trusts to their portfolios.

Property investment companies, due to the nature of the asset class, are on average among the more highly geared sectors Annabel Brodie-Smith

He comments: “Property investment trusts currently offer yearly dividends of 5 per cent and discounts to net asset value (NAV) of 9 per cent on average.

“Investment trusts have not been forced to suspend withdrawals, as their shares are not traded on the open market and their access to permanent capital means they are not obliged to sell the underlying property investments if investors want to cash out.”

Indeed, he highlighted AIC research that showed post Brexit, the average discount to the NAV for UK property investment trusts is 9.4 per cent, “potentially offering value compared with the long-term trend over the past three years”.

Table 1: UK property investment trusts from 23 June to 20 July

Source: AIC/Morningstar/Thomson Reuters Datastream/QuotedData

Moreover, there have been positive news stories from the listed investment trust sector. For example the Drum Income Plus Reit saw no change to its share price post-Brexit.

Because it invests in smaller properties in regional locations, it can - says James Carthew, head of research for QuotedData - “target smaller properties in regional locations where it can achieve higher yields because there is less competition”. As at 11 July, it had a yield of 5.1 per cent.

Also, at the time this guide was published, Derwent, a FTSE 250-listed Reit had a current dividend per share of more than 40p; its underlying fundamentals show a strong trajectory over recent years, despite the post-Brexit hiccup.

Derwent’s fundamentals Source: London Stock Exchange/Morningstar

Reits must, by their nature, pay out 90 per cent of the income they receive, which means “many trade on attractive yields”, says Mr Carthew.

Reits can also stash up to 10 per cent of their income away during good times, helping to smooth returns for investors when there is a rainy day.

Adrian Lowcock, investment director for Architas, says: “Reits do tend to perform differently to equities, so they provide excellent diversification benefits.

“They can also borrow money to invest so can provide leveraged exposure to the asset class - while the manager is not forced to hold cash or sell investments.”

Volatility and gearing

However while Rob Gleeson, head of research at FE, believes Reits are a good way of getting round the liquidity issue, he adds: “The downside is they behave more like equities in the short-term, so are prone to the same market movements.”

Doug Millward, investment manager for Lowes Financial Management, says Reits can be useful to access more niche areas of the property market, but agrees with Mr Gleeson.

Mr Millward says: “It is worth noting Reits are directly affected by equity market movements. It follows, then, these have not been immune to the negative impact of concerns around property values.”

Phil Clark, head of property investing at Kames Capital, says: “While Reits invest in property, their share price is often affected by wider stock market moves, and are therefore more volatile than the commercial properties in which they invest.”

The AIC’s Ms Brodie-Smith says: “Of course property investment companies or Reits are not unscathed by the Brexit decision and have been affected by the change in sentiment.

“Discounts for the UK direct property investment company sector widened from a 5 per cent premium at the end of 2015 to a 9 per cent discount, clearly having a tough short-term impact on their returns.”

One main difference of Reits and closed-ended property investment companies to open-ended funds, is that Reits and closed-ended property funds can gear to enhance performance.

This can help to boost income and capital growth but will also increase any losses on the downside, something of which potential clients should be made aware.

According to Ms Brodie-Smith: “Property investment companies, due to the nature of the asset class, are on average among the more highly geared sectors. For example, the Property Direct – UK sector is currently 29 per cent geared.

“However, the sector had clearly been positioned for a lower growth environment with lower levels of gearing at a lower cost prior than in previous economic cycles.”