The Investment Association (IA) will split its property sector in two this September. It’s not exactly a defining moment in history, but it is a helpful one for investors.
Instead of the current mishmash of some 48 open-ended funds investing in anything from UK office blocks to Asian property company shares, there will be two far more distinct categories: funds investing in ‘bricks and mortar’ and funds investing in shares of property-related companies.
Here is our guide to which type of fund is best for you.
Bricks and mortar
This type of fund invests in physical property – office blocks, warehouses and student quarters – which is let to commercial or residential tenants, providing an income through the rental yield and hopefully some capital returns.
They have two main benefits: they can be good diversifiers in a wider portfolio, as the commercial property market tends to behave differently from stock markets, and they generally offer a decent level of income.
On the other hand, they are ‘illiquid’: as any homeowner will tell you, it can take a long time to buy or sell a building, so these funds have to hold some money in cash. If investors sell in droves and this cash buffer isn’t enough to meet redemptions, these funds can be forced to suspend trading, for a time. This happened in 2016, after the EU referendum, and was seen very negatively by some. But I think it was the right thing to do, as it stopped panic-selling in its tracks and most property funds regained their pre-Brexit values within a year. But it does mean that if you need instant access to your money, you may want to choose another option.
Like any shares, property shares are correlated in the short term with stock market movements. It’s only over the longer term that returns are more linked to the underlying physical property market. The advantages are that you can buy and sell shares relatively quickly and these funds don’t need a stash of cash to deal with investor flows. They will also contain a lot of shares from companies in different sectors, rather than a small number of large and expensive buildings.
Post-Brexit, shares in the property sector fell significantly and property investment trusts went to a discount – up to 30% in some cases. So while investors can still access their money in these funds or trusts, stock market falls and big discounts mean that they could be selling at a loss.
Since Brexit, more investors favour property funds
Which to choose?
Since Brexit, more investors have favoured property shares. But I’m still a fan of both, as long as you understand the risks. Investors need to decide if they can stomach the possibility of shorter-term volatility in property shares, in exchange for easier access, or if they are happy to invest money they won’t need in a hurry in bricks and mortar.
Premier Pan European Property Share is one of my preferred share options. It invests in high-quality companies in the UK and Europe that actively manage their property portfolios. It has a yield of 3.7%.
I also like F&C Real Estate Securities, which invests in the same regions, but also ‘shorts’ companies where the managers think the price of shares will fall.
My preferred investment trust is TR Property Trust. It invests in UK and European property shares, and also has a small amount invested in physical property. Its managers look for well-run businesses in retail, office, residential and industrial sectors.
For bricks and mortar funds, I like Janus Henderson UK Property, which mostly invests in commercial property and related assets. The managers focus on high-quality tenants on long leases, a significant portion of which are linked to inflation. The fund has one of the highest occupancy rates in its sector and one of the highest yields.
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’s views are his own and do not constitute financial advice.
DARIUS McDERMOTT is managing director at Chelsea Financial Services and FundCalibre