Reits of spring for investors

Reits of spring for investors

As the Financial Conduct Authority considers the future for open-ended property funds, it is a good time to weigh up the options for investors who are attracted to real estate, but are concerned about the volatility in both open-ended property funds and the big listed property companies, most of whom have real estate investment trust (Reit) tax status.

Real estate has long been the investment of choice for those looking to match long-term liabilities due to its high income return and capital protection qualities.   

While often seen as a capital growth asset, this is normally a short-term phenomenon in real estate markets and is frequently driven into a bubble by over-zealous investors.

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In truth, real estate investment is at its best when investors seek the thing real estate is best at delivering – long-term secure income. Indeed, over long-term measures it should be expected that compound income return will make up more than 75 per cent of total return from property. 

Investors who are fixated by liquidity may find that the income return they must forego to achieve that liquidity comes at great cost to long-term total return.  

This is evident in the open-ended fund structure, where income returns are typically 50-60 per cent of those achievable in a property investment company (often referred to as a closed-ended fund).

This discounted income return is the price of daily liquidity in the funds’ units. The open-ended structure was laid bare in July and August 2016 when the majority of open-ended funds suspended trading due to more than £1.25bn of redemptions, sparked by fears surrounding the EU referendum.   

The promise of liquidity vanished, just when investors wanted it most.   

These funds must be differentiated from property investment companies (closed-ended property funds). These funds operate an investment trust structure – often with Reit tax status and external management – where the unit of liquidity is not a unit of net value (as in open-ended funds), but in main market listed shares, possibly the most liquid market in the developed world.  

Property investment companies differ also from the big listed property companies/Reits, which are internally managed. They are often engaged in development and typically have significantly lower target dividends, with greater emphasis on capital growth.   

The listed property companies/Reits tend to demonstrate a high correlation with equity markets and can prove much more volatile than the underlying property markets in which they are invested. 

If you are looking for an investment in real estate with both a high income return and daily liquidity, there is only one choice.

Property investment companies may demonstrate some short-term volatility in share prices, but over the long–term they have proved to have a close correlation with property market performance.   

As with any investment, timing is a crucial component of the investment decision.   

While investment markets have been running hot for a couple of years – which could lead investors to conclude that the best market timing is behind them – occupational dynamics, particularly in regional markets, are robust.

There is a real supply-demand imbalance driven principally by an acute shortage of supply and, with limited speculative development in the pipeline, there is no imminent threat of an increase in supply any time soon.