Should you be holding property in your investment portfolio?
In just the last month three major property funds have announced that they are either suspended or closing down completely.
Does this mean time is up for property as an investment?
Not necessarily. Global property is still huge. It’s estimated that global real estate is valued at around $326trillion. To put that into perspective that’s more than all global equities and fixed interest combined.
It’s still the biggest store of wealth.
To consider whether you should be including property funds in your portfolio you need to understand what sort of returns you can expect and how the risks differ from other types of investments like equities (the great companies of the world).
The main ways of including property in your investment portfolio
For most people buying a physical property to rent out is not going to be an option. It will cost too much, there will be ongoing fees and maintenance to pay and there is a hassle factor.
For investors who want to keep things simple but still include property in their overall portfolio there are property funds.
A property fund works in the same way an equity stock market fund works. There will be a fund manager and investors will pool all their money together and the fund will buy physical commercial property. This will usually be retail units, hotels, office blocks and warehouses. The idea being that these types of properties will produce a rent and appreciate in value over time.
There are two main types of property funds, an opened ended fund and a closed ended fund.
An open-ended property fund, also known as an OEIC will be valued based on the total of all the underlying properties. The properties held inside the fund won’t be valued everyday but on a periodic basis. This can cause issues, more on this later.
A closed ended fund, also known as a Real Estate Investment Trust or REIT for short still invests in physical property but the underlying fund price does not reflect the value of all the property but instead the demand for the share in the REIT.
For example, if demand for property is high, investors maybe queuing up to buy shares in the REIT, this may cause the price of the REIT to exceed the actual value of the underlying property holdings. Similarly, if demand is low, the underlying share price might be cheaper than the value of the underlying property.
It’s not a case of one type of property fund is better than the other, it depends on what characteristics of each approach suits you better. Let’s explore these next.
Is it worth including property in your investment portfolio?
If you are going to include an asset in your investment portfolio you want it to do one of two things, either to help you generate better returns or reduce the overall risk of your portfolio.
One element of risk is volatility. The movement in prices up and down.
One of the main characteristics of a property OEIC is that it can appear much less volatile than a REIT and equity funds.
This is because the underlying property is not valued everyday like shares in an equity fund. It’s a bit like the value of your own home. If you asked people what they would pay for your home every day, you would get lots of different opinions day by day. In reality, because you only value your home every few years or so, it appears that it grows consistently.
A REIT will behave much more like an equity fund because the price of the fund is influenced by the demand for a share in the fund.
You can see this when comparing the returns and volatility of the Legal & General open-ended fund vs the iShares closed ended fund.
On first look you can see that the returns from the Legal & General fund appear much smoother than the iShares fund. This may be a good thing if you don’t like the wild swings in prices every day, but it is a little misleading. The value of the underlying properties may in fact have fallen in at a particular point in time it’s just that they have not been officially valued yet.
One of the biggest problems with a property OEIC is liquidity, being able to withdraw from the fund as and when you want to.
If too many investors want to sell out of an OEIC the fund manager needs to start selling the assets in the fund. This can be a problem as selling a large commercial property is not a quick thing and it could be during a time in the market cycle where there are not many buyers. So, on these occasions you can often find that open-ended property funds suspend trading, meaning you can’t buy or sell units in the fund. This gives the fund manager time to sell what properties it needs to. This can be a problem for you if you need access to your money. You can’t get it during a suspension.
A closed ended fund doesn’t need to suspend because you are only buying shares in the fund and buying and selling them from other investors. If there were lots of sellers at once it would just reduce the price of the shares significantly to the point where buyers were attracted. So, liquidity shouldn’t be an issue.
The problem with REITS is that because they operate like equities they tend to be as volatile as equities.
The main reasons you diversify and hold different asset classes in your investment portfolio is because you hope that as one asset class goes down in price a different asset class will go up in price, as economic conditions might be more favourable for one asset class over the other.
This doesn’t tend to happen with REITs. If the general stock market goes down, then REITs tend to follow.
In terms of performance, REITS don’t tend to outperform stocks over the long term.
In recent years there have been certain events that have impacted property investments more compared to equities. For example, since Covid there has been a tendency for more office workers to work from home reducing the value and income from office buildings.
The current rising interest rate environment has also made debt on property more expensive and hit income profits.
The performance of technology stocks has also lifted the global stock market in recent years further increasing the difference in returns between stocks and property.
So, should you hold property in your investment portfolio?
Well, if you are focused on the long term, believe in the underlying properties that your chosen fund has purchased then an open-ended property fund can be a good way to reduce the overall volatility of your portfolio. However, you need to be prepared to go through phases where you will be unable to access your cash due to fund suspensions. This is why focusing on the long term is key.
REITs will be better for you if you are worried about liquidity but still want some exposure to property however if you are going for maximum long term returns global equities have outperformed property over the long run.
One thing to understand if you are considering including property in your investment portfolio is what your exposure to property is already.
Clearly if you are a Buy to Let landlord then you will already have a large exposure to property and it may be unwise to add further exposure.
You might also already be indirectly invested in property either via a global equity fund or via a stock that has a large exposure to property.
A general global equity fund will have around a 2.5% exposure to real estate through companies involved in the property sector.
Also, whilst you may think you are investing in a business, the business itself might gain much of its income from property.
Take restaurant chain McDonalds for example. You may think it makes all its money from selling food, but it actually owns 45% of the land and 70% of the buildings across its 36,000 plus locations. It makes its money from buying and selling its properties and collecting rent from all the franchisees.
So, as always with any investment, take the long-term view, look at the evidence and find a portfolio that best suits your financial plan.
If you would like to get your retirement sorted then please get in touch for a free no obligation 15-minute call. We would be happy to review your position, explain where you stand and what you need to do to get the outcome you desire. We have created hundreds of happy and protected retirements over the years. This could be you too.
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.