The current success and prominence of property as an investment vehicle makes it easy to forget that as recently as five years ago it was a small, seldom used sector for the retail investor.

Recent IMA figures indicate that property was the largest individual sector for positive inflows in 2006.  The increasing focus on portfolio building together with the recent performance and volatility of the equity markets have encouraged this trend, but are we all just jumping on the latest bandwagon?  What options are now available for the retail investor and what proportion of a portfolio should be invested into this asset class?

There is always an element of investing in the latest growth area and it seems likely that property investing has benefited from this type of investing, however the main difference between property and other boom markets, such as the dot coms in the late 1990’s, is that property is not a new market, having been around since investment began.  What is increasingly apparent to the retail investor is the continuing solidity of the residential market and the wider availability of other property investments and it is this that has driven interest and hence demand.

The retail investor has three main property investment options:

• Residential property
• Commercial property
• Property shares 

Until recently these have been UK focused, however, more global property options are now becoming available with new launches such as Norwich Union’s Global Property fund.

Residential Property
In terms of residential property most individual investors are already top heavy in this area given property price rises and the growing buy to let market. Private pension portfolios in the UK have nearly two thirds of their assets in property of which a substantial amount is residential.

Collective Investing in Commercial Property
The remaining two investment choices have always held restrictions in the form of the available investment options, if one assumes the average investor will not be buying direct commercial property or buying individual property company shares.

The range of collectives now available goes some way to addressing this, although property supply is still not plentiful and this brings up the first point of caution in this market – the supply and demand of property worthy of investment.

Given the influx of investment over the last few years there is some caution over the availability of good commercial properties for these funds to buy into. Yields have come down on commercial property over the last year as capital values have gone up and securing a good property yield is proving increasingly difficult. The large players still believe there is a healthy rental market, particularly in London and the surrounding area, but this cannot go on forever and you have to be careful about how far the market has to go.

From an investors perspective there is still a relatively small number of property funds, compared with other areas of the investment market.  The reasons relate to the supply of property and the skills of people to manage them. It is not easy to start a retail property fund given the barriers to entry, and building a realistic portfolio without overloading in the riskier property areas is not straightforward.  

Property Shares
Property shares were the other alternative on our investment list and the biggest advantage they have over ‘bricks and mortar’ investing is the liquidity they offer. The recent introduction of REITs (Real Estate Investment Trusts) has seen a number of companies including British Land move to this new format and this may in the future offer more alternatives to the retail investor, although at the moment they should remain under surveillance for the average investor. All the immediate gains to be made by investors have been absorbed and the average investor will not be able to benefit from this change. 

The biggest disadvantage of property shares is that they are shares and will therefore react more in line with the general equity market, unlike direct property investment. Again, it is important for the investor to look at what is being invested in as there are very few collective investment schemes that are invested mainly in property shares although the Aberdeen Property Share Fund has been very successful at this. Other funds often use property shares to provide liquidity in their funds and New Star is an example of this.  

The Current Outlook
So, is property still a good place to invest and if so, how much of the portfolio should we be looking at?

The property market is in general reliant on the health of the overall economy and current interest rates, but is not as correlated to the economy as closely as equity prices. Commercial property is the least correlated asset class to equities and bonds. In particular, as rental agreements have increased in length over recent times the ‘security of income factor’ has increased. This puts the asset class in a strong position to offer a great diversification play in a portfolio and may also provide a more secure income stream.

At the moment a number of analysts are indicating that the good times for commercial property are coming to an end and that the rising interest rate environment and the weakening economic position of some major markets is a sign that this is not the best place to invest for the future.  Even pro-property investors are expecting overall returns to fall from the double digit returns of the last three years to single digit, but they are not expecting the assets to suddenly correlate to equities, should world stock markets fall back on economic uncertainty.

This lack of correlation means that property of some kind should have a place in a balanced portfolio.  The weighting given to this asset class depends on the client and their risk profile. Our view is that property exposure in the range of 5-20% is generally an appropriate weighting.  It is likely that an income portfolio should have a greater bias to property to provide both security and a reliable income stream, but this would fall into the percentages already mentioned. As far as timing is concerned you have to consider that there have been three years of very strong growth and it would be rash to expect this to continue.

Rayner Spencer Mills
April 2007