How to invest in property

What you’ll learn:

• What commercial property funds invest in
• How easy it is to sell your investment
• If property behaves in the same way as stocks and bonds

When it comes to investing, one term you will often hear is how important it is to be diversified. Namely you should spread your investments, so that if one falls, the others might support you.

Over the years the tools used by investors to do this have changed. For a long time the old rule-of-thumb 60/40 model of investing 60% of your money in bonds and 40% in shares was used, in the hope that if one of these assets fell, you would be able to ride this out by gains in the other.

Then along came the global financial crisis and the rules changed. Investments that were thought to be uncorrelated to each other all fell in tandem, leading investors to question long-held assumptions about diversification. It led to the search for asset classes that perform differently to bonds or equities. These are often referred to as ‘alternatives’ and a popular one has been property.

When we say property, this isn’t buying a second home or tying your money up in other forms of residential property. We are talking about funds that invest in commercial property, such as office blocks, retail parks or industrial buildings. In addition to offering the potential for a relatively uncorrelated source of returns to bonds and stocks, these funds also offer prospects for income. This comes from the rental paid by commercial tenants. Rentals also might be agreed for a set number of years and can provide extra certainty that income will keep coming in.

But such income flow from properties is not guaranteed. Indeed, certain commercial tenants, particularly struggling retailers on the High Street, have over the last year or so been actively seeking to cut their costs by renegotiating rents mid contract.

Economic uncertainty sparked by the shock Brexit result in 2016, highlighted the risk of investing in open-ended funds with direct holdings in property. Several funds were forced to suspend dealing as investors hit the panic button and tried to sell out. At the end of 2019, the sector was in the spotlight again after the M&G Property Portfolio fund suspended dealing, following £1bn of investor outflows. These are just some of the challenges facing the commercial property funds – and have called into question the suitability of these types of funds for non-professional investors.

So just what are these funds and do they stack up as a genuine diversifier in your portfolio? We put together this Q&A to help you understand property as an investment.

What is a commercial property fund?

There are two types of commercial property fund. You can invest in a direct fund that puts money into physical bricks and mortar, meaning the fund buys buildings outright. Alternatively you can choose an indirect fund that simply purchases the shares of property companies or other property funds.

Both types of fund ultimately have exposure to a range of different commercial properties, either directly as owners or indirectly as shareholders in property companies. The most popular underlying investments are retail spaces, offices and industrial outlets, such as warehouses. The performance of these properties don’t all behave the same – as anyone following the ongoing challenges for High Street retailers will know.

The funds can invest solely in the UK, or globally or hold real estate investment trusts (REITs).They can also be actively managed or track a specified property index. Given one invests in listed shares and the other physical property, it is also important to note the outcomes for investing in each will be different. The performance of the former will be linked to the profitability of the shares of the companies the manager invests in. The returns for the latter will depend on the actual value of the properties the fund invests in - and the rental achieved.

Can I get my money if things go wrong?

Both direct and indirect commercial property can be accessed through open-ended funds that deal every business day. Open-ended funds in general are designed to have no restrictions on the number of shares available so investors should be able to invest into the fund, or sell out of it, whenever they like - the fund manager will create new units when you want to buy and invest that money, then cancel the units and sell some of the underlying holdings when you want your money back. In theory, therefore, with open-ended property funds, you should be able to get your money out when you want.

However, following a mass of outflows in July 2016 following the Brexit vote, a number of funds suspended dealing because they didn’t hold enough cash to pay out to so many investors wanting to sell their holdings at once. This happens because selling a property – as any home seller will know - takes a lot longer than selling shares in a company.

Closed-end funds such as investment trusts, by contrast, issue a set number of shares, which are then bought and sold on the open market. The stock market works to make sure there’s always a buyer when you want to sell, though you might not like the price you get.

Samina Chaudhary, a portfolio manager in Barclays Investment Solutions, notes that daily dealing open-ended real estate funds are at risk if large numbers of investors seek to liquidate their holdings at the same time during periods of uncertainty.

Samina said: “Such mass redemptions pose a major problem for direct property funds, because despite having daily-dealing, it takes them time to generate the cash needed to meet requests as properties cannot be sold as quickly as shares can. If these funds didn’t suspend dealing, they would be forced to sell their better quality assets, which are likely to find buyers more easily - and so dilute the quality of the overall portfolio.”

In an attempt to prevent a repeat of the problems that hit the direct funds in 2016 in the wake of the Brexit referendum, many funds have raised the levels of cash they hold in their portfolios. They now hold between 12% to 20% in cash. While this does provide a buffer against high levels of redemption, the concern is that those investors looking for income are not being served by having so much held in cash.

Given that indirect property funds are invested in shares, which are much easier to buy and sell than physical property, investors do not face the same problems pulling their money out if needed.

Do these funds behave in the same ways as stock markets and bond markets?

It all depends on your investment time horizon. In the short term, given that indirect property funds are invested in shares, their performance can be influenced by what is happening in the wider stock market. Meanwhile, as previously stated, because the returns made from direct property fund investments are linked with the actual value of the property and the rental income generated the performance of these funds is typically less correlated to shares or bonds – at least in the short-term.

However if you look over the longer term, which you should do when investing in this type of asset class the similarities between listed and direct property funds start to show themselves.

Samina explained this is because these companies are more influenced by what is happening in property development than they are by the movements in the overall stock market. If you are investing in an actively managed fund where managers make the investment choices, rather than one which tracks a property index, you want to choose a manager with the expertise to assess the risks taking place in the wider market.

What drives the performance of these funds?

Overall, how property performs is driven by the health of the general economy, such as employment prospects, inflation and how confident consumers are feeling. During periods of economic growth and inflation, such as in the 1990s and early 2000s, property will usually provide a positive return because demand for space increases, pushes up rents and encourages more construction. Conversely, in a downturn, such as happened during the 2008-2009 financial crisis, there will be a rise in tenant vacancies and rental voids, development will slow, rents will flatten or even fall and property values decline. For this reason, a clearer picture surrounding the impact of Brexit on the economy should before too long provide greater clarity for investors.

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The value of investments can fall as well as rise. You may get back less than you invest. Tax rules can change and their effects on you will depend on your individual circumstances.