A simple way to hold global property assets

With Article 50 now triggered, the risks that the economy and UK assets will fail to meet growth and return expectations have increased. The end result may or may not be favourable, but markets do not like uncertainty.  

Sterling has borne the brunt of concerns for now, losing 15 per cent of its value on a trade-weighted basis in 2016. This year it has fallen another 1 per cent, at the time of writing. It would be nice to think most of the currency’s weakness is behind us, but markets will be quick to further punish the pound on any developments that look bad for the already large and problematic UK trade deficit. 

The uncertainty created by the Brexit decision means the justification for investing outside of the UK now has even more merit. The opportunities investors are familiar with domestically can all be found in other markets. Investors can buy shares in many well-known companies, whether they are German industrials, Japanese car manufacturers or US technology firms.

 Reits have been a positive development for property markets globally, attracting more capital into the sector

Bond markets have similar characteristics, and the US offers much broader and deeper credit investment opportunities. But what about real estate, and how can UK investors get exposure in international markets to an asset class they favour domestically? 

Property companies have been listed on the London Stock Exchange for many years, but it was not until 2007 that the real estate investment trust (Reit) structure was introduced in the UK. Reits first emerged in the US in 1960 and in the Netherlands in 1969, but it has only been in the past 10-15 years that the structure has been adopted globally. 

The UK Reit structure exempts the company from corporation tax on profits and gains from UK-qualifying property rental businesses. To qualify for this tax exemption, Reits must distribute at least 90 per cent of their taxable income, which is treated as property rental income rather than dividends, and moves taxation of property income from the corporate to the investor. A similar tax treatment applies in each country where the structures exist.

Reits have been a positive development for property markets globally, attracting more capital into the sector, improving the amount and quality of investment and contributing to general economic growth. Listing requirements mean the structures have to be transparent and adhere to corporate governance and reporting requirements that are not always present in the unlisted sector.

From September 2016, the Global Industry Classification Standard created an 11th sector classification dedicated to real estate. As a result, Reits and real estate management and development securities have been carved out of the financial sector classification and grouped together.

Meanwhile, the FTSE Epra/Nareit global index captures a large part of the Reit investable universe, with around 550 securities and a total market cap of $2.2trn (£1.8trn). This has increased investor interest and makes the Reit sector difficult to dismiss. 

The fundamental attributes to look for in Reits are a defensive yield and sustainable earnings growth, and by design the structures pay out a substantial amount of their earnings. This limits the potential for future earnings growth, but it does not eliminate it completely. 

Reits distribute income via dividends that are largely derived from the rent produced by the properties owned and operated across sectors as diverse as offices, residential, hotels, retail, healthcare and industrials. Earnings growth comes from the ability to raise rental income through property improvements, inflation, general economic growth and lease terms. As the value of properties rise, there is the potential for capital growth since the properties are traded over time. 

The ability to trade shares daily means Reit share prices move up and down much more than changes in the underlying values of properties. This short-term volatility need not concern long-term investors and can be managed where Reits are held as part of diversified portfolios. The sensitivity of Reit share prices to changes in bond yields, for example, can be mitigated as part of an overall duration management strategy. 

For a nation that is very keen on domestic property as a store of value, global Reits provide an easy way to access the risks and rewards of holding global property assets without having to buy property directly or invest in unlisted funds. 

Vincent McEntegart is manager of the Kames Diversified Monthly Income fund