Advisers cautious on new wave of residential property vulture funds

The steep fall in residential property prices over the last 18 months has resulted in the launch of a number of vulture or distressed assets funds, which aim to buy properties while very cheap with a view to profiting from them when markets go back up.

These include Property First Asset Management’s UK Property Recovery No. 4 late last year, the London Central Residential Recovery Fund, Residential Property Recovery Fund and Assetz UK Residential Recovery Fund No 1.

And more should be on their way: James Sullivan, managing director of alternative asset fund specialist PILinvests expects to see a steady stream of this type of residential property fund coming onto the market in the second half of this year, because more opportunities will arise as it is expected there will be an increase in the number of distressed sellers.

The returns on offer from the funds look attractive. London Central Residential Recovery Fund, Assetz UK Residential Recovery Fund No.1 and UK Property Recovery No.4 LP are targeting a 15 per cent return per annum, while Residential Property Recovery Fund is targeting an internal rate of return of 16 per cent.

Sullivan said: "We’ve seen falls of around 25 per cent since peak prices. We’re now seeing distressed or forced sellers, for example, cash strapped or over leveraged developers disposing in bulk and offering enticing discounts on current valuations to anyone with equity."

"We may not yet be quite at the bottom of the market but we’re very nearly there and these kinds of opportunities will not be around forever. We’ve probably got a window of opportunity for up to 18 months to get our hands on the very best deals and maximise yields and capital appreciation."

"In a few years we will look back at 2009 and 2010 as being vintage years for funds."

Stuart Law, chief executive officer of property investment advisers Assetz, argues that while it is very difficult to predict the bottom of the market, if you aggregate a number of the leading house price indices falls have been getting lower since January. He adds that analysis of all the major house price indices shows a 10 per cent annualised positive growth in May.

A more detailed analysis of this can be found at his online blog.

But Gavin Haynes, managing director of IFA Whitechurch Securities, is not persuaded that that the market necessarily has hit the bottom.

He said: "The correction in house prices is a fall from what were bubble valuations, and it is possible the economy could fall further. Or if there is a short term recovery and interest rates rise again this could put the brakes on any recovery we see in the housing market, so that it would go down again."

Mike Horseman, managing director of IFA Cockburn Lucas, said: "Making a call in any direction is premature as it is uncertain as to whether there will be double dip inflation. Providers of these funds have an interest in calling the bottom of the market."

But what is of even greater concern to Horseman is that typically these residential property funds are not regulated and are illiquid due to the nature of the underlying assets.

He said: "You have no payback if these funds do not deliver, and if they collapse you get nothing back. But if you buy into a regulated investment you will get up to £48,000 back."

"These unregulated funds should be treated with a high degree of caution, although could offer opportunities to investors with the right level of knowledge, who have a larger set of assets, can speculate and have a high risk appetite."

Haynes adds that there is such a wide range of regulated UCITs compliant funds smaller investors do not need unregulated funds to diversify their portfolios.

Horseman also believes that residential property does not offer much diversification for most retail investors, especially if the portfolio is denominated in Sterling. He said commercial property, by contrast, offers exposure to different assets such as offices, warehouses and hotels – both in the UK and overseas.

Haynes adds that many smaller investors already own a home against which they hold mortgage debt, so there is little reason to have even greater exposure. Although a fund spreads risk it is difficult to know how correlated the assets are to each other, while a number of these funds have gearing which raises the risk/return profile.

But Naomi Heaton, chief executive officer of London Central Portfolio argues that most people’s homes are unlikely to be correlated to the assets in a specialised fund. The London Central Portfolio funds, for example, are focused on central London prime residential property which is subject to different economic influences to much of the rest of the UK property market.

Heaton said an advantage of residential property funds is that they give smaller investors access to a property market they could never access directly, and offer exposure to maybe 25 to 30 units as oppose to one. Investing in a fund also means investors do not have to manage and maintain the property as with buy-to-let.

Sullivan said it is important to select a fund with an asset manager which has the expertise and experience to be able to source the best opportunities in the right locations. He said: "A lot of new fund managers are coming to the market but what is important is whether they have the right track record, and are not investing in an area which is overdeveloped."

"You need to make sure the company offering the properties is not just looking to deleverage its balance sheet but can demonstrate that it can make returns."

He adds that in some instances it might be better to invest in a less geographically diverse fund if it means the managers know the area well.

London Central Portfolio has 20 years of investment experience while Assetz has been investing since 1999 and launched its first fund in 2005 for the Sipp market. However there is little publicly available data to demonstrate how these funds perform.

Assetz would not provide any data for its funds, though Central London portfolio said its two year old fund, London Central Portfolio Property, has fallen 4 per cent in value since its launch in 2007 in contrast to its benchmark, Land Registry central London flats and maisonettes which is down 19.5 per cent. All Land Registry central London property is down 25 per cent over that period.

Dave Butler, director of corporate affairs at listed residential landlord Grainger, adds that buyers of residential property funds need to be very clear on the nature of the underlying assets and how they are managed, and to ensure that they are bought at the right price. For this reason he believes residential property funds are far more suitable for institutional investors.

Butler adds that residential property held in funds is very different in that it typically offers exposure to a rental market as well as capital growth, and you are buying into someone else’s management capabilities. He said returns can be very different to direct property ownership.

In any case the existing funds in the market are not easily accessible to smaller investors, as they require a minimum investment of around £25,000 or higher, though if investing via a Sipp or SSAS it can be as low as £5,000.

This would still require a larger investor however, because allocation to this asset typically should not be more than 10 to 20 per cent, according to Colin Jackson, director of Baronworth Investment Services, or 5 to 10 per cent according to Horseman. And investors must be prepared to invest in it for the long term.

Another problem for less experienced investors is the current lack of advice available because residential property recovery funds are a relatively new asset class meaning not many IFAs can advise on it. Haynes adds: "Because these funds are very specialist it is hard to get enough information on them, in particular regulatory information because a number of them are offshore."