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Property sector

Property sector

Property is a deceptively diverse asset class but can broadly be split into two: residential and commercial.
Josef Licsauer

Josef Licsauer - Investment Analyst
4 November 2021

Investing in property is much more than just buy-to-let. While there aren’t many funds that invest in residential property, commercial property offers plenty of investment opportunities. It’s broadly divided into three areas: retail, industrial and office. Most investors access this part of the market through property funds or REITs (Real Estate Investment Trusts).

There are two IA (Investment Association) fund sectors devoted to property. The IA UK Direct Property sector contains funds that invest in bricks & mortar. The IA Property Other sector includes funds that invest elsewhere, such as overseas or in property company shares.

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Our view on the Property sector

The performance of property funds usually depends on how the economy’s doing. In good times demand for property increases. This pushes up rents and property prices and encourages more construction. During slowdowns or recessions the opposite happens.

Commercial property is normally preferred by investors in need of an income. That’s because most of the returns come from rental income. As with any investment the value of property investments and the income they could provide can fall as well as rise.

Funds investing in physical property

Property funds that invest directly in bricks and mortar are popular with investors, but we don't think they're the best way to invest. This is because commercial property is not easily bought and sold. It’s time-consuming, labour-intensive, and expensive.

This creates problems for fund managers. Investors usually want to put a lot of money into their funds when performance is good and the outlook is rosy. But because it can take months to find and buy suitable properties, the manager often ends up holding a lot of cash and missing out on rising property prices.

Similarly, when the outlook isn’t so good, or when performance has been poor, investors tend to sell property funds. This often forces the manager to sell properties in order to give investors their money back. The best properties are often quickest and easiest to sell, so remaining investors can be left with less attractive investments.

To help with this issue fund managers adjust the pricing of their funds and can stop investors trading them. These decisions are not taken lightly and only in extreme circumstances. It does mean you could receive less than you expect when selling a property fund, or not be able to sell at all for a period of time.

This can hurt the fund’s performance and means returns aren't solely down to the skill of the fund manager. The high costs associated with buying and selling property also eat into the income received by investors, more so than when buying and selling shares.

Funds investing in property company shares

These funds work in a similar way to funds that invest in company shares. The value of the fund is directly linked to the value of the shares the manager invests in.

They mostly invest in REITs. REITs own and operate a variety of properties and are looked after by an expert management team. This helps to spread risk and means they don't rely on a small number of properties.

You can also invest in REITs, and other property-related investment trusts, directly. These don’t have the same problems as unit trusts when large numbers of investors try to buy and sell at the same time. But it's possible for the shares in the REIT or investment trust to trade below (or above) the value of the properties they invest in. This is known as trading at a discount (or premium).

Investment trusts can also borrow money to invest, often called gearing. This can improve returns when markets are rising, but increases losses in falling markets, so it’s higher risk.

We think investors who want to invest in a specialist area should make sure it forms a small portion of a diversified portfolio.

Investment notes

Please remember past performance is not a guide to future returns. Where no data is shown, figures are not available. This information is provided to help you choose your own investments, remember they can fall as well as rise in value so you may not get back the original amount invested.

Last year proved a challenge for most funds, and property funds were no exception. But we’ve seen signs of recovery so far in 2021, helped by low interest rates, which have boosted consumer spending, and the success of the UK’s vaccination programme.

Property isn’t out of the woods yet though. Concerns around rising Covid cases and new variants have delayed the ‘return to normal’ and increased pressure on parts of the property sector.

The future of offices for example, remains very difficult to predict. People have been moving out of the city to embrace remote working and reduce costs. As a result, some office space is seeing less demand and rising vacancies. Many companies have signalled their intention to retain at least some office space though, with many implementing new ‘hybrid working’ models, where employees split their time between working at home and in the office.

In the retail space, pandemic-induced lockdowns reduced the volume of foot traffic which meant things like shopping malls were impacted. The subsequent shift to purchasing goods online has also dented demand for retail property. Non-essential shops have re-opened, but foot traffic is still lower than pre-pandemic.

Industrial property investments have been the star performers of 2021 so far. The acceleration in e-commerce boosted demand for distribution centres, while self-storage facilities also saw increased demand for their services.

Direct property fund suspensions

A number of UK property funds suspended trading in March 2020, meaning investors were unable to access their money.

This happened because market turbulence made it difficult to value the assets held in direct property funds. Without accurate property valuations, fund managers can't properly calculate a fund's unit price. That means there's a risk that if the funds continued trading, investors could buy or sell units at a price that doesn’t properly reflect the value of the underlying assets. Ultimately, some could benefit at the expense of others.

Since then, some direct property funds have closed permanently and returned the proceeds to investors due to liquidity concerns. Several other funds suspended in March 2020 have managed to lift suspensions and resume trading. Many have maintained higher levels of cash, and other liquid assets, which can help meet demand in the event of an increase in levels of redemptions.

The spread of coronavirus is something of a one-off event. But it wasn’t the first time property funds were forced to close. The last time a large number of property funds were forced to close was following the 2016 Brexit vote.

Investment notes

Please remember past performance is not a guide to future returns. Where no data is shown, figures are not available. This information is provided to help you choose your own investments, remember they can fall as well as rise in value so you may not get back the original amount invested.

Property fund reviews

The fund reviews below are provided for your interest but are not a guide to how you should invest. For more information, please refer to the Key Investor Information for the specific fund. Remember all investments can fall as well as rise in value so you could get back less than you invest. Past performance is not a guide to the future.

There is a tiered charge to hold funds on the HL platform. It is a maximum of 0.45% a year - view our charges. Comments are correct as at 30 September 2021.

Source for performance figures: Financial Express

This fund mainly invests in real estate investment trusts (REITs). It also invests in companies that don’t invest in property but make most of their money from the property industry.

The fund is mostly invested in companies that own, manage or develop UK properties. Some of them specialise in niche areas such as hotels, student accommodation or healthcare buildings. The portfolio also includes companies that don’t invest in property directly but that have a big link to the sector. Examples include storage companies Big Yellow Group and Safestore.

Part of the portfolio is invested in countries across Europe, like Germany, Sweden, Switzerland and Belgium. The fund can invest up to 20% overseas, which means it’s not solely reliant on UK-based businesses.

The managers don’t invest in many companies. That means each one can have a big impact on performance, but it adds risk.

This fund aims to track the performance of the FTSE EPRA / NAREIT Developed Index as closely as possible. It invests in hundreds of property companies worldwide.

More than half the fund is invested in North America, with the rest spread over Europe and developed Asian countries. Roughly 5% is invested in UK property companies. This could make it a good option to diversify a portfolio with more invested in UK property, or if you’re worried about the prospects for the UK property market.

iShares is run by Blackrock, one of the largest providers of tracker funds on the market. They use their size and expertise to keep costs low, which helps them mirror the index. So far, we think they’ve done a good job – the fund's tracked its index closely and efficiently over the long term, although past performance is not a guide to the future.

The fund invests in some smaller companies. These could offer higher growth potential but they’re higher-risk than larger companies.

This fund buys a mix of high-quality commercial properties across the UK, with a South East bias. Investments are well-spread between retail, office and industrial properties. The managers have the flexibility to use derivatives, which adds risk.

When the managers buy a new property they often refurbish or modernise it. They hope this makes it more desirable to potential tenants, and more likely they’ll sign longer leases. If this happens the value of the property could increase.

Sustainability is important to the managers. Not only from an ethical point of view, but also because it could reduce costs in the long run and help prevent buildings becoming outdated. Examples include installing solar panels and electric vehicle charging points.

Like many direct property funds, the Janus Henderson UK Property PAIF suspended for dealing in March 2020. The suspension allowed the managers to raise cash to a level they felt could cover potential client redemptions going forward. As of 24 February 2021, the suspension lifted and trading recommenced.

Please note the fund's charges are taken from capital. This increases the yield, but reduces the potential for capital growth.

The manager invests directly in properties all around the UK, with over half the fund covering the South East, West Midlands and South West.

The fund’s investments are well-spread across the UK and it owns almost 90 properties. 44% of the fund invests in industrial property, with the rest invested in UK office and retail property. It can also invest in the shares of property companies as well as REITs.

High quality properties are preferred and the managers aim to improve their value by working closely with their tenants and building managers. They think this helps keep buildings fully occupied and improves long-term performance. The manager can use derivatives to invest, which adds risk.

The managers don’t invest in many companies. That means each one can have a big impact on performance, but it adds risk.

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Investment notes

Please note the research updates are not personal recommendations to trade. If you are unsure of the suitability of an investment for your circumstances please seek advice. Remember all investments can fall as well as rise in value so investors could get back less than they invest.