With latest research suggesting advisers intend to pile into the UK Reits market when it opens in January, it is perhaps time to pause for reflection.
Reits are at heart merely a more tax-efficient way of owning property together with other investors. It does not mean the underlying asset itself – whether residential or commercial property in the UK or elsewhere – will perform miracles come January 1st, 2007.
The danger, therefore, for the industry is another scandal based on a herd instinct, resulting in too much money chasing poorly performing assets and a future “told you so” waiting in the wings.
Most clients are probably overweight in residential property right now given how prices have surged in the past decade – those with seem to think their retirements are sorted, while those without are looking to take on 50-year mortgages, longer than the average working life.
Commercial property incomes are good because the UK economy is performing well and rents just keep rising, but a recession could undo all of that.
Arguably equities prices have also, briefly, gone too far on the basis of PEG and other ratios, making up for lost time when investors should have been buying assets on the cheap – say, in 2003. All of which means surging into property via the stock market may be the worst of both worlds.
Of course, on the basis of annual remuneration as a proportion of asset value inflation some may see sense in steering people into equities and both residential and commercial property. But, there are other considerations, quite apart from whether these asset classes are being handled to the best advantage of both short and long-term client financial goals, including levels of acceptable risk.
The emergence of Reits will likely force investors to think about property in a completely different way. The requirement forcing these vehicles to pay out nearly all income earned in the form of dividends means investors will essentially be looking at property for its income-generating potential, rather than its long-term capital appreciation potential.
Tax issues aside, the focus on income means investors will pay far greater attention to dividend yields than total yields when comparing returns. By definition this may force them to take a more volatile year-on-year (rolling figures) view of the bricks and mortar in which they hold a share, rather than view the smoother curve presented by a more proportionate mix of capital appreciation plus dividend yield over the longer term.
And there will be a requirement to review the relative sizes of Reits on offer. A big property company in the traditional listed sense – British Land or Land Securities – would be considered a safer bet than a smaller player because of the ability to spread risk around a greater catchment of geographical and local economic factors. However, under the Reits structure, evidence from markets such as the US and Canada suggests investors may find greater advantage in the options smaller, niche players offer.
By definition being smaller means being able to offer proportionately greater growth opportunities to investors. More importantly from the Reits perspective, being small in a specialised area such as, say, high-security biological research laboratory infrastructure as part of general healthcare infrastructure, means being able to tap into far greater income possibilities from drug research budgets than generalist leisure, entertainment or shopping complexes can from Joe Public’s wallet.
Not all commercial property is equally adept at generating growing income. Developing new drugs is inherently risky, hence the rewards will be potentially greater.
Geography is a necessary factor in this mix too. UK residential and commercial property-focused Reits face competition from global Reits. Consider, for example, how the price of residential units required is going to depend on basic supply and demand factors.
On this basis, the idea China and India’s combined population of 2.5bn will require modest but decent new housing over the next 50 years possibly carries greater weight than the idea the UK’s ageing housing stock will require a shift in supply from family units (houses) to empty-nester flats.
Also, both commercial and residential property requires land: the UK is surrounded by water which by most accounts is going to get deeper over the next half a century, raising the price of land, but not necessarily to the advantage of the property actually built on it.
Unless rents can be increased even faster, the rising price of acquiring land will depress income yields, even as capital appreciation from freehold ownership goes up, but this again runs into the problem of the new focus on income distribution, which is the price companies must pay to convert into Reits to gain the tax advantage.
By all means use the pending Reits market to review and ensure a client’s portfolio at least maintains a similar exposure to property on the basis of risk. But beware of using the new market as an excuse to go overboard in shifting money into bricks and mortar, unless the reasons are extensively compelling.
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Jonathan Boyd on 020 7484 9769 or email [email protected].IFAonline
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