This month's roundtable debate looks at the boom in property funds, with the panellists discussing the outlook for the sector and, in particular, the implications for such business in the Channel Islands
For some time the industry has been talking about the boom in bricks and mortar, with 2006 seeing a raft of property fund launches. With this in mind, this month's International Investment Power Hour discusses property funds, looking in particular at the opportunities and threats facing the Channel Islands and what factors are fuelling the growth in this type of asset class.
On the panel were Graeme McArthur, managing director at Northern Trust, Kevin Mundy, director of real estate services at BNP Paribas, Tamara Menteshvili, chief executive of the Channel Islands Stock Exchange (CISX), Andrew Weaver, an advocate at Bailhache Labesse and Alan Campbell, senior manager of corporate finance at Royal Bank of Scotland International. Chairing the discussion was Tanya Bird, editor of International Investment.
Property funds appear to be a real success story for the Channel Islands in recent years. However, do you think going forward that changes introduced in the UK Budget, will impact businesses in Guernsey and Jersey? Particularly, as the Government withdrew seeding relief, which had previously been used to transfer properties into offshore unit trusts without having to pay the 4% stamp duty land tax (SDLT).
Graeme McArthur (GM): The Budget changes were widely expected. While seeding relief benefited some structures in the past, SDLT has not been the only driver behind the establishment of funds in Jersey. There are so many other reasons for setting up a property fund in Jersey and the listings should continue to increase in the Channel Islands, despite the Budget changes.
Tamara Menteshvili (TM): On the contrary, the Budget has opened up a raft of opportunities for the Channel Islands, considering the CISX is a recognised stock exchange for Real Estate Investment Trusts (Reits). Presently, there are 75 property funds listed on the stock exchange with nine new listings so far this year. This includes open and closed-ended funds, which invest in a diverse range of areas from the UK, emerging markets and Europe. As the Channel Islands have a track record in the establishment and administration of property funds, more managers could use the jurisdiction to list products.
Andrew Weaver (AW): There has been a flurry of private structures that were principally designed to exploit SDLT. But this is not the only reason why these funds have come to Jersey, it is because the island is known for its expertise. The withdrawal of seeding relief is unlikely to have an impact on the more general real estate funds business.
Kevin Mundy (KM): It is possible there could be a slowdown in the private structures that invest in properties to save tax. However, the removal of seeding relief will make no difference to property funds where investors buy and sell unit trusts. These types of funds are still going to exist. This argument is backed up by the fact that in the last 11 months, of the 11 new funds set up only one used seeding relief.
AW: Managers will continue to use Jersey property unit trusts as disposals of the properties within the trust are free from capital gains tax. Another reason for its continued use is the fact that an offshore fund structure is subject to lighter regulation than in the UK. For example, in an offshore vehicle, it is possible to mix investors within a unit trust, whereas in a UK structure there are separate exempt and non-exempt investors. Units can also be transferred free of SDLT, which is another tax advantage for investors once the property investment is in a unit trust. Therefore, investors using a private structure should still gain benefits using these products.
TM: Another interesting aspect in the marketplace is the switch between investor types. Five years ago there used to be predominately closed-ended funds designed for institutional investors, now there has been a shift towards more open-ended products, which retail investors have been using.
Do you see any specific growth areas going forward, particularly in the UK, Europe and emerging markets?
GM: There is growing demand for European property as returns in the UK appear to be tailing off. This has led investors to look further afield from the traditional UK market. One such area is Western Europe, which has a very sophisticated market, but in terms of fund choice in the region, it is underdeveloped. We see a lot of potential in Western Europe, Eastern Europe, the Australasian market and the Middle East.
In contrast to the last comment, another trend that has been noted is the fact European investors are looking at commercial property in the UK. Do you think this is a future growth area?
GM: In 2005 the commercial property sector performed exceptionally well. There is a feeling that because 2005 was such a good year for the sector, 2006 will not be so good. However, it is thought commercial property will still grow this year, but not at the levels seen in previous years.
TM: It is possible to invest in property through numerous different sectors such as residential, industrial, commercial and retail. Institutions are also looking at much more specialist investment opportunities such as mortgage-backed securities and collaterised debt obligations. Over the next 18 months, the specialised derivative markets will continue to grow and this is where the Jersey property expertise will become invaluable.
GM: There will also be more development in the area of fund of funds as Jersey's expertise in this area grows.
Is the development of the fund of funds industry happening now or is it something that will occur going forward?
GM: There are not a lot of fund of funds structures at the moment. Most funds have been closed ended, which makes it difficult to convert to a fund of funds structure. There has been a shift towards open-ended funds more recently, which makes it possible for fund of funds products to be set up.
KM: A lot of established property funds have begun amending terms to become fund of funds vehicles and a lot of companies are now realising the best way to invest in the London central property market, for example, may not be directly but through the use of a fund of funds vehicle, which helps to spread risk.
What happens if this asset class were to crash?
Alan Campbell (AC): The global property market is very well diversified. It is unlikely there would be a crash on a global basis, because there are always going to be areas that will hold up in a crash.
KM: Not all property would take a dive at the same time. Property funds are well placed to deal with a crash because most diversify between sectors to reduce risk.
GM: At one end of the spectrum, investors can put money in a low-risk property investment. For example, the UK commercial property market can be considered an investment that has a high yield but is relatively low risk. At the other end of the spectrum, investors can place their money in more speculative higher-risk property investments such as Eastern Europe, where the risk and returns are much higher. Both are very different types of asset and very different investors would look into each of these areas.
AC: To help reduce the risk for investors, fund managers need to have local partners on the ground in the country they are investing in. The local partners need to understand the market, the legal framework and the risks involved. This is especially important in areas like the emerging markets where risks are higher.
TM: A fund must also have liquidity so investors can redeem units if they want to get out.
What are the liquidity issues in property funds?
KM: Liquidity is important in the early stages of setting up a fund, when the manager is looking to buy assets to put into the structure. However, once a manager has bought the assets for the product, in order to be cost effective and to gain the maximum amount of growth for the investor, the fund needs to be fully invested rather than just have cash sitting in the bank.
TM: What is also important for property funds is the administration costs behind the product such as the expense associated with surveyors and lawyers. All this can have an impact on the price of the product to the end investor.
Many offshore property funds have a reputation for high charges and high gearing, but do the end returns justify the cost of gearing/risk taken?
AW: There will be demand for products as long as the price is right.
KM: Putting some facts and figures on it, the retail warehouse sector returned 24.5% compared to 4.5% in a bank account, so naturally people are going to believe property is a good investment opportunity.
Do you think the popularity of property funds is also on the up because of people's attachment to this type of asset?
AW: This is definitely the case at a retail level. Property is easy for people to understand and investing in a fund is an easy way for some to get a foothold onto the property ladder. Although a lot of investors have no understanding of loan to value, yields and the interest cover, they know that even if there is a price collapse the fund holds a piece of land.
TM: There has been a bear market in equities. Against this backdrop, people are looking for other investment opportunities and property is what people understand.
GM: A lot of people want to invest in property, but do not have the finance to purchase a buy-to-let investment, considering there are void periods if a tenant is not found and maintenance costs to consider. Some investors prefer to go through fund structures to diversify the risk, as well as get into the market at a much lower level with a defined expectation of return.
AC: There are some markets where it is difficult to buy property as an individual investor. One such area is China where it is only possible to invest in real estate through a property fund. By way of a fund, opportunities become available for investors to get into a market that they would not normally be able to consider.
Are UK Reits a threat to the Channel Islands and are there more reasons to set up onshore?
GM: The introduction of UK Reits will open up opportunities for investors to gain access to both the commercial and residential markets. It will also add liquidity to the market with increased activity in buying and selling. Whether the introduction of UK Reits will have a negative impact on offshore structures, time will tell. The feeling is the two structures will co-exist.
AW: UK Reits will need to be listed on a recognised exchange, which includes the CISX. The Channel Islands could see a lot of new property fund business because compliance costs are lower on the CISX compared to London and UK advisers are aware of its position. A CISX listing might also be useful for an investment manager who does not need to raise capital. Another opportunity exists for Jersey companies wanting to establish themselves as a Reit, because the structure only has to be tax resident in the UK, not an English corporate.
However, one challenge facing the Channel Islands is the Isle of Man, which recently changed its regulations in relation to real estate companies so a structure could be established from there. The Channel Islands will have to keep a close eye on what other jurisdictions are doing and who has their eye on the Reit market.
How important is strong regulation?
KM: Regulation is very important because it provides a strong framework from which to do business within. It is also important for moving the industry forward. For example, two years ago legislation was changed so expert funds could be established within 48 hours compared to up to six weeks. The fast establishment of a fund is another reason why a manager might use the Channel Islands to list.
AC: There is also ongoing dialogue between the regulators and the companies setting up the funds, which helps in the process of establishing products.
Is it only a matter of time before supermarket platforms and wraps are able to have offshore property funds shown on them?
GM: Technology is a large part of the development of any asset class. Investors always want more flexibility and access to details in a clear format, all of which fund supermarkets can provide. However, the use of technology supermarket platforms always depends on investor demand.
TM: Supermarkets create a market value - investors can find fund information independently as well as gauge prices.
The abolishment of seeding relief will not have a major impact on property funds in the Channel Islands
New business expected to be created as a result of the introduction of UK Reits, because funds will be able to be listed on the CISX
Investors looking further afield than the UK, turning to Europe, Middle East and Australia to invest in property
Putting the tech into protection
Square Mile’s series of informal interviews
Fallout from Haywood suspension
Launching later in 2019
£80bn funds under calculation