Sales of funds investing in UK commercial property have dominated the UK retail market over the past 12 months. According to the Investment Management Association Statistics, the most popular net retail sector in 2006 was the Specialist with sales of £4.4bn. Of this, property funds represented more than 80% inflows, with net retail saes of £3.6bn.
Now, following the introduction of real estate investment trusts in Britain at the start of this year, sales of funds investing in property may be set to increase even further.
Reits are property companies that pay no corporation tax. While they were introduced in Britain on January 1 this year, the structure has existed in America, Australia and the Netherlands for decades. Reits also exist in France, Japan and Hong Kong, and are set to be introduced in Germany and Italy later this year.
To gain Reit status, a property company must fulfil several criteria, such as distributing at least 90% of its net income profits to shareholders. A company must also be listed on a recognised stock exchange. For a company to convert to a Reit it must pay the government a conversion charge equivalent to 2% of their gross assets.
Ian Hally, investment director, real estate securities at Scottish Widows Investment Partnership, says thus far nine British companies have converted to Reit status. However he says these companies, which include British Land and Land Securities, are the biggest property companies in the UK market. Indeed he says by market capitalisation, 70% of UK property companies have already converted to Reit status and he expects this to reach 80% by the end of the year.
One of the primary benefits of converting to Reits, for both companies and investors, is the elimination of double taxation. Reits essentially remove the double tax of corporation tax paid by the company and tax paid by the investor on dividends and capital gains. This puts investing in property securities on a par with direct property investment.
Reits also have to pay out 90% of their rental income as dividends. For example, Hally says that since Land Securities converted to a Reit it is able to distribute 30% more rental income than it did in the past.
While investors can invest in single Reits, it is funds which invest in a portfolio of Reits which is expected to be the way most retail investors get access to the market. The last two years has seen a host of UK fund management houses launch funds which invest in a portfolio of global Reits, and now UK Reits are available groups have also begun launching UK-only Reit portfolios.
Hally says: "When Reits were introduced in the US, Congress stated it introduced them to make large income producing realestate accessible to the small private investor. Now, over the middle term, the greatest impact of the Reit market has indeed been felt in the retail market."
The attraction of investing in a fund of Reits is twofold, adds Hally. From a diversification point-of-view, he says investors get exposure to an asset-class, which historically, is lowly correlated to equities and bonds. "The introduction of Reits will also maintain this diversification benefit, because over the long-term their performance has a close relationship with the underlying real estate market as opposed to the wider equity market," he adds.
Ben Yearsley, senior investment manager at Hargreaves Lansdown, says he expects the yearly return from a fund investing in global Reits to be in the 9-14% region. This, he notes, is higher than the return you can currently get from a fund investing in direct UK commercial property.
Hally meanwhile expects a 10-12% return from global and European Reits over the next 12 months. Thereafter, over the medium term he says he is telling investors to expect 7-8%.
"It all depends where the fund invests," Yearsley says. "A high exposure to the Far East/Japan will likely net you a higher return than investing in the US, but you will be taking more risk. It's best to invest with managers who can be flexible and invest anywhere in the world."
Indeed it is the global Reit funds, rather than pure UK Reit funds, which Yearsley believes hold the most appeal for investors. "A fund solely investing in UK Reits is not any different to the UK commercial property funds you can currently buy. There is no difference between the two in terms of diversification. Global Reits however do add diversification to a portfolio, as they are less dependent on just one geographic market," he says.
Indeed Hally adds one of the main diversification attractions of Reits is they allow British investors the chance to invest in non-UK markets. "We would recommend UK investors hold a pan-European or global Reit fund," he adds.
That said, Hally adds there is a valid argument for having exposure to UK Reit market. "There are some very good companies that manage real estate in the central London office market. That area has performed very well, and we expect this to continue for the next few years," he says.
Swip has a suite of three Reit funds. On June 1, 2006, it launched the Swip Multi Manager Global Real Estate Securities fund, this followed the launch European Real Estate fund on September 20, 2005. In May last year it launched a fund dedicated to investing in UK-only Reits, the Swip UK Real Estate fund.
Despite being launched before the official introduction of UK Reits, Hally says the fund has been investing in those companies it knew would convert to structure on January 1. Today he says 60% of the fund's £9.5m assets are invested in Reits.
Despite the current popularity of commercial property fund amongst investors, Yearsley does not expect the sale of Reits to have a large impact on the amount of money currently flowing into the sector. Indeed he believes it will actually take money from the existing property unit trusts.
"The people who want to invest in property already do," he says. "Reits will take some of their allocation away from where they currently invest, but it won't necessarily attract more money into the sector."
01 February 2007