Kira Nickerson looks at a possible move away from commercial property as technical barriers towards creating a viable residential property fund appear to be lifting.
Residential property is beginning to appear on advisers’ radars as increasing scale and availability shifts the balance away from commercial property.
Historically, there have been a number of technical barriers to creating a viable and attractive residential property fund for retail investors and, until recently, the lower returns from the asset class also made it a less attractive choice. But with lower return expectations today, plus greater demand for diversified and low volatility assets, residential property merits a closer look.
According to Christopher Down, founder and CEO of residential property specialist Hearthstone Investments, among the historic technical barriers to UK residential property funds has been the lack of property management operators with scale.
Why more advisers may consider residential property funds
Without this, a fund manager would be left to handle all aspects of managing the individual properties. Today there are several such firms that have national coverage, as well as the necessary systems to provide FSA-regulated retail funds with the frequently updated management data needed for accurate fund pricing.
For its fund, Hearthstone uses operators such as Touchstone, which manages some 20,000 homes on behalf of corporate and institutional landlords, taking care of activities such as rent collection and maintenance.
Tax inefficiency has been another hurdle, relieved somewhat in 2007 with the introduction of the open-ended Property Authorised Investment Fund (PAIF) structure.
This FSA-regulated structure allows bricks and mortar collectives to be taxed in a similar way to REITs, in the hands of the investor rather than the income being taxed within the fund itself.
This makes it particularly attractive for tax wrapped investments via pension funds or ISAs.
According to Down, a bricks and mortar fund yielding 5% within a PAIF versus one outside this structure would have a return difference of around 100bps for tax-exempt investors. “That 1% in tax saved is a substantial benefit of the new structure for some investors, effectively paying for the AMC on a fund,” he said.
One of the last big barriers to drop was in March 2011 when the government disaggregated stamp duty.
Previously, the Inland Revenue would have added up all the properties within a residential portfolio and a large-scale buyer would have been hit with the highest rate of stamp duty as if the properties were a single asset.
Stamp duty liabilities on properties acquired in bulk now average about 1% instead of 4% as a result, Down said, and have contributed to the initial cost of investing in residential funds becoming significantly cheaper.
Now it is easier to create an open-ended residential fund, investor interest is the next ingredient, and today’s uncertain and low-return investing climate is well suited for greater demand.
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