Funds that invest in the property sector are becoming increasingly popular as investors turn away from poor performing equity markets
Despite the volatility in global markets and a UK economic slowdown, UK house prices are continuing to rise, creating an attractive opportunity for investors.
Property investment can fall into three broad categories: buying property direct, that is, buy-to-let, investing directly in property company shares, and investment in property funds such as unit or investment trusts. And clients can enter the market at many differing levels.
The area of property investment that gains the upper hand in many investors' minds is the buy-to-let market, and the growing competition in the market means there is a good range of loans available to help clients buy properties for investment.
For those clients who do not relish becoming a private landlord, there remains the choice of investing in a fund, such as a unit or investment trust, in quoted property companies, or buying commercial property.
Mike Boles, director of Savills Private Finance, is wary of individuals using funds as an alternative to buy-to-let, however.
He said: 'While funds are an alternative, I do not know how viable they are. When people invest in property through funds, it is normally as part of a spread on their general investment portfolio rather than as an alternative to buy-to-let. There are not many decent property funds around and most are institutional.'
However, there are advantages to funds. Boles added: 'They are a lot more liquid than holding properties directly, and you get a spread without having to buy hundreds of properties. Property investment funds are one of the steadier asset classes.'
Until recently, property was not considered a 'proper' asset class by most investors. Individuals and institutions alike frequently invested directly in property rather than through an asset manager or fund as they would with equities. Hence there is only a limited choice of unit trusts and investment trusts available that invest solely in property.
There are currently just four investment trusts and three unit trusts on offer. The investment trusts are Trust of Property Shares, Wigmore Property Investment Trust, TR Property Investment Trust and Real Estate Opportunities. The unit trusts available are Aberdeen Property Share, Norwich Property Trust and Portfolio Property.
The idea behind these funds is that they invest in a selection of property companies and directly in property itself. Naturally, the composition of the funds differs.
TR and Wigmore are both funds that invest in property shares, Wigmore completely and TR with some direct property investment. Norwich holds some 75% in property and 25% in property shares, but is holding around 20% in cash at present. Real Estate has a higher risk profile as it has exposure to European high yield securities.
The property investment trusts have suffered in recent volatile equity markets.
Nick Sketch, an analyst at stockbroker Carr Sheppards Crosthwaite, said: 'Everyone is convinced a slowdown in the economy is coming. The stock market has already reacted to that, and peoples' expectations of the economy have reacted to that, but rentals on commercial property have not.'
The market has already taken into account that rents will come under pressure and default rates rise in the price of the trusts. However, if investors think this is unlikely to happen, then these trusts may look like a cheap buy, according to Sketch.
One advantage of investment trusts is that they may trade at a discount to their net asset value, which means investors can, in theory, pick up exposure to the property sector more cheaply than buying shares direct.
In the case of property trusts this situation is magnified. Sketch said: 'If you buy an investment trust, you are buying a portfolio of property shares at a discount to the quoted asset value. Their portfolio contains lots of property companies that are themselves trading at a discount to their quoted asset value. Thus the effect is cumulative.
'However, there is a downside. Obviously you can have an investment priced at a discount to the underlying value for some time, and with no mechanism to get the money out, it may not help. The catalyst for releasing the value is always the question.'
A more basic entrance into the property market is through direct investment in property companies, although by doing so, the amount of spread gained is reduced. General investors buy this sector of the market as well as those specifically interested in property.
Giving an overview of the sector, Clive Stevenson, a research analyst at Barclays Stockbrokers, said: 'In this sector we are relatively neutral at the moment, just because it has outperformed strongly in the last 18 months. Due to the economic slowdown we are in at the moment, we are seeing demand for office and retail space start to fall, putting pressure on rents, and this is feeding through into the valuation of the companies.'
Stevenson said that the sector does have defensive aspects to it, especially in the present climate of low interest rates. If an investment in the sector has a yield of 8%, and it is possible to borrow money at 6%, then it looks very attractive.
However, he is keen to point out that the case for the sector's defensive qualities are sometimes overstated. 'There is also a quite limited supply of good commercial property at present,' he said, 'so the weakening demand is being partially offset, although nobody is sure by how much. Some people will have gone into property as they see it as defensive but I do not think it is immune. As soon as people return to cyclical stocks, the sector is going to underperform.'
Stevenson was unable to name any property company specialising in the residential side of the market. If commercial property companies have any exposure to the residential market, it tends to be a small part of the overall portfolio offering little exposure, he said.
Sliding further down the scale of investment is direct investment into commercial property.
It is at this level that the individual previously only considering residential buy-to-let may be interested. However, while financing at this level of market entry is similar to the residential buy-to-let market, being the only level at which investors borrow to increase the value of the investment, they are different markets.
Leases, for example, are more certain on commercial property. Pritchard said: 'The difference between commercial and residential property is that if I have a building let to ICI I know it will pay the rent until the end of the lease, whereas if I let a house to Mr and Mrs Smith, they may go off into the sunset and it may take time to re-let.'
Yet because these markets are so different, they attract different types of investor.
Rob Clifford, managing director of mortgageforce, said: 'People looking to become a landlord wish to own property and see a physical monthly return. We do not see a lot of people in the psychological or strategic sense looking to invest in property, although if we did, a property fund may satisfy that demand. Our experience is that clients do not want to invest in the property market per se, but want to get involved physically with ownership of property.'
Before investing in commercial property, there are a number of issues to consider.
The investment is not as liquid as many and capital gains tax applies on sale of the property. Tax is payable on any rental profits and there are added costs such as empty periods and management fees to consider.
In the early years, such investors are essentially gambling on property price increases.
While people who can afford to pay for property outright can find this an excellent investment, there are pitfalls that can make it a costly nightmare for those who do not do their homework.
However, the outlook for this market is good for those investors not looking to make a fast buck. Neville Pritchard, UK investment partner for property consultants King Sturge, said: 'In terms of where the market is going from here, while short-term rates seem to be slipping downwards, the medium to long-term rates seem to have stabilised and fixed rate debt is going to become cheaper.
'The majority of private investors are interested in well-let, good quality commercial properties, like a market town shop or a small industrial building. That is where the market has been particularly strong.'
The property market as a whole offers investors a broad range of targets with varying amounts of risk and involvement.
Funds spread risk through exposure to a broad expanse of the commercial property market.
Individual property companies, in general the constituents of the funds, may outperform such a broad-based investment by skilled management, and still offer a level of spread in the market.
Both these investments miss out on the huge returns that could have been made in past years through selling residential property that had been purchased as an investment directly some years before.
But housing markets do not necessarily rise forever and there are risks, especially in the early years before equity builds up.
The commercial property market is driven more by the economy than the housing market, which is more wages driven and localised, but offers a more hands-off and depersonalised approach to owning rental property.
18 new entrants featured
Recommended cash offer
Latest news and analysis
Second London acquisition in three years
Partner Insight: Continuing the Architas education series for clients.