28/03/2007
Getting Your Timing REIT
One of the questions exercising investors' minds right now is how best to include property in a balanced portfolio, given the strong inflation hedging characteristics the asset class offers over the medium to long term.
Among the attractions is the fact that property cycles are positively correlated with economic cycles, meaning that property investments tend to perform well when economic conditions are positive. This feature is driving a number of property markets ahead none more so than markets in Asia, such as Singapore and Hong Kong. However, many of these markets are not within the group of UK property investors. So, how can they access them?
Over recent years, UK pension funds have been able to satisfy their growing appetite for property either directly or indirectly by using managed pooled property funds or exempt property unit trusts. However, it has been less straightforward for private investors to invest in commercial property, especially in a diverse, tax transparent and readily tradable format. As a result, the use of private property vehicles has increased although some of these vehicles may not offer the level of diversification and liquidity that retail investors are seeking.
The arrival of the Real Estate Investment Trust (REIT) in the UK as an investment option should extend the current property cycle, as more investors, who might otherwise have been deterred, are drawn into the asset class. This in turn will lead to increasing demand for property investments.
Initially developed in the United States, and subsequently adopted by key property markets such as Australia and Japan, REITs offer a transparent, liquid, tax-efficient way to invest in property. As the name suggests, a REIT is an investment trust, which invests predominantly in property, and is traded openly on the stock market. By allocating money to a REIT, an investor is taking a stake in a company which has the main purpose of owning and managing investment property.
In the UK, legislation requires that 90% of the profits generated by rentals must be passed on to investors. This should boost the dividend yield, making such investments more attractive to investors and funds that require income. Over the last few years, the strong demand for exposure to the asset class has been met in part by direct property funds. However, these funds can present a liquidity challenge, both to investors and investment managers.
Managing property directly calls for difficult decisions to be made. Among the issues that need to be addressed is how to control liquidity as a way of balancing the needs of investors against the requirement to strike good deals in the property market. One potential impact of this is that it may force investment managers to place restrictions on investor access to cash, for example by imposing withdrawal notice periods.
However, through buying shares in REITs, which are traded freely on stock exchanges, these barriers are removed, ensuring an investor has a unique level of flexibility, while still enjoying the sought after exposure to property as an asset class.
The timing of the government's announcement on UK REITs is unfortunate in some respects, most notably because it came at the end of a decade of strong property returns, as the UK adapted to becoming a low inflation, low interest rate economy. Hence, the valuation metric between rental yields and swaps or gilts rates has turned negative. However, there are many overseas property markets that exhibit much more favourable conditions for generating attractive returns going forward.
This is where the diversification offered by a Global REIT fund can play a part. Not only does it ensure positive exposure to the best performing markets, it also offsets the level of volatility inherent in any one market. It is possible to take advantage of the low correlations between different quoted property markets by balancing exposure across regions, dampening volatility and smoothing returns over time.
Reliable research suggests that global property remains an attractive asset class, as liquidity and transparency improve. However, it is becoming more important for investors to pay increasingly close attention to valuation concerns, which are deteriorating in some areas. Hence there is a need for strong active fund management in order to take advantage of divergent regional property cycles.
There is no doubt that performance track record and service standard should form part of the selection process. So, for investors puzzling over how best to achieve exposure to the property market, a Global REIT fund may be the answer.
Andrew Jackson, fund manager of the Select Property and Global REITS funds, Standard Life Investments
First published in Money Marketing on 22 March 2007
Standard Life Investments Limited, tel. +44 131 225 2345, a company registered in Scotland (SC 123321) Registered Office 1 George Street Edinburgh EH2 2LL.
The Standard Life Investments group includes Standard Life Investments (Mutual Funds) Limited, SLTM Limited, Standard Life Investments (Corporate Funds) Limited and SL Capital Partners LLP. Standard Life Investments Limited acts as Investment Manager for Standard Life Assurance Limited and Standard Life Pension Funds Limited.
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