13 October 2016
Why own property funds
By Darius McDermott, managing director
After a surge in redemptions following the Brexit vote, many property funds were forced to suspend trading. Most are now re-opening, including the Elite Rated Henderson UK Property. So how has this affected our views on property funds?
In my opinion, these recent events should by no means be a cue for investors to avoid the asset class altogether; property remains a valuable diversifier. It won't always be the star performer in your portfolio, but it is traditionally uncorrelated to other asset classes and therefore offers something different to equities and bonds.
With buy-to-lets undergoing a raft of tax and regulatory changes in a bid to curb housing unaffordability ― and with residential property prices in key markets such as London unattainably high for many investors ― property funds could play an important role in providing that exposure.
Before you buy, however, it's important to be clear about how these funds work, the reasons you would buy and when you might expect them to struggle.
Perhaps the most important thing that investors need to understand about property is that it is an illiquid asset. In other words, it can be difficult to buy and sell quickly. Crucially, this is the case whether you invest in a buy-to-let or units in a fund (as the fund's underlying investments are, of course, also physical properties).
Generally speaking, funds will be more liquid, as they retain a certain amount of cash to pay out when investors sell their holdings. The problem after Brexit was that far more people than usual wanted to sell on the back of a gloomy UK commercial property outlook. Eventually a fund's cash reserves will run out in that scenario and then it has to sell some of its actual properties to meet redemptions. This obviously can't happen overnight and so many funds temporarily suspended trade.
In the long run, this was a smart move. Had funds been forced to sell rapidly they may have had to accept firesale prices, destroying their capital value. Plus the break gave people a chance to cool their heads and make sure they weren't getting swept up in sentiment selling.
Although it's important to be aware they are always a possibility, these closures are reasonably rare – the last time we saw a round of closures was during the financial crisis in 2008. Normally money can be in your bank account within eight working days of a sale, as with most other fund investments. Even during a period of suspended trade, funds continue to pay out distributions.
If you own a buy-to-let, however, and you need to get hold of your money in a hurry, it could be a different story. Property can sometimes sit on the market for months or even years. You might be forced to take a big hit on price if have to sell at the wrong moment.
Unless you're fortunate enough to have many buy-to-let properties, the lack of diversification can be a risk for buy-to-let investors. By investing in just one or two buy-to-lets, you are essentially putting all your eggs in one basket. Although the wider housing market might do well, your properties might not. For example, the government might decide to build a new power station five miles from your property. Or perhaps you discover your property has a major issue like subsidence.
Funds are naturally much more diversified. They tend to have many underlying holdings meaning that if one does badly it does not necessarily have a large impact on your investment. You can also buy multiple funds in different asset classes (i.e. not just property), investing around the world, to give yourself a really good mix.
When renting out your property, estate agents typically charge between 7 and 17% of your rental income for a full management service fee. (This is Money has some good information on letting agent charges.) That compares with an actively managed fund where the fees may be around 1.35% a year in total on average (including an estimated platform charge)¹.
Furthermore, buy-to-let property comes with ongoing maintenance and bill costs. I think people often underestimate these. Properties will also need to be regularly updated and renovated. There will be ongoing insurance charges and other costs. Arguably, these costs do also apply to investors in property funds, but not in quite the same way. They may be levied through the fund's management fee, for example, but they won't be a direct out-of-pocket expense for which you have to come up with cash.
Another issue with buy-to-let property is how much time and effort it can take to manage. The process of buying and selling is not easy. Plus, depending on whether your property is fully managed by an agent or not, you may also have to spend a lot of time overseeing the property and looking after tenants.
With funds, you can quickly buy and sell either online or with a five minute phone call. The bigger issue is choosing the initial investment, which can seem daunting. FundCalibre has three Elite Rated property funds, one of which is the Henderson UK Property fund that buys physical, commercial property in the UK. The other two provide access to the property market via listed property companies. Short-term these behave like shares, but over the long term they have a greater correlation to property yet with a better liquidity profile than they physical assets.
Where to next?
- You're not as diversified as you think
- How to choose a fund
- How to invest in property without the mortgage
¹Average annual fees calculated as follows: Chelsea Financial Services service charge 0.4%; Cofunds platform charge 0.2%; average fund annual charge 0.75%
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius' views are his own and do not constitute financial advice.
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