a Sainsbury's supermarket, with an unexpired lease term of 28 years and annual RPI increases, recently traded at a yield of 4.1%.
Choosing to invest in property
Charities, like other investors, have been thinking much harder about where to allocate their money since the global financial crisis. Negative real interest rates continue to make cash unattractive and increasingly bonds look expensive. Equities have had a good run in the last few years but the volatility that goes with them can make conservative investors nervous.
It would be no surprise to charities, which by nature are quite conservative investors, to know that many surveys of institutional investors show that real assets have become more popular - and especially property.
A number of charities have been investing in property for a long time. They are attracted by the relatively high, stable income it provides, which is the ultimate goal for many charities which rely on their investments to maintain their activities. But what should those charity investors starting from scratch or which are looking to raise exposure to property know about the asset class? How do they invest and what are the benefits and pitfalls?
Attractive option
The most common type of property invested in by "institutions" can best be described as "commercial", which includes retail outlets, offices, industrial and alternative uses such as leisure, hotels etc. This is an attractive option considering the high level of total return delivered through income (70-80%), the improving economic picture and the benefit of having a real asset should inflation pay an unexpected visit.
However, it is important to choose the right parts of the market to invest in or find someone who can find them for you. So where should a charity invest? Many pension funds are switching out of corporate and government bonds which are very low yielding and are now perceived to be expensive. The interest on 10-year gilts is 2.8%, which is below inflation with RPI running at 3.2%. In effect you are losing money in real terms. Index-linked gilts are yielding 0% in real terms.
To illustrate how much more attractive property can be than government bonds, it is possible to access index-linked property investments at yields of 4% plus. A Sainsbury’s supermarket with an unexpired lease term of 28 years and annual RPI increases recently traded at a yield of 4.1 per cent. A 25-year lease to Tesco on a supermarket with annual RPI increases recently traded at a yield of 4.25%. In comparison an index linked Tesco bond trades at 0.9% per annum. So you are 335 bps (base points) better off and you also own the real estate.
Alternatively, you can go slightly higher up the risk curve and acquire a Premier Inn hotel (with a guarantee from Whitbread) for a yield of circa 6% on the basis of a 20-year lease with rental increases based on the Consumer Price Index, compounded annually but payable every five years.
Higher yields
Higher yields, sometimes up to 9% a year depending on the length of lease and quality of the asset, can often be sourced in the industrial sector of the property market, which includes manufacturing assets such as factories, and distribution such as warehouses. These investments can often be purchased at "build cost", which means 100% of the value is tied up in the real estate rather than the lease.
The manufacturing sector has benefited from the resurgence in the UK car industry over the last five years and the logistics sector has experienced strong occupier demand for space through the increased need for "just in time" deliveries and the rise of internet retailing. There has also been a lack of new construction since 2007 as developers and banks have drawn in their horns. This, combined with low obsolescence and good occupier demand, means limited empty space. Therefore this sector can provide a very high relative yield but with strong defensive qualities.
Charity investors should also think about geographic regions. London continues to outperform the rest of the UK in economic terms and this is reflected in rising prices for real estate. Population growth is projected to continue to increase and economic improvement is also being driven by regeneration (think Stratford, Kings Cross and Nine Elms) and infrastructure spending (Crossrail).
There is also value to be had in up and coming areas, such as Old Street/Shoreditch, Clerkenwell, Southbank and Vauxhall, to name a few. However, stock selection and pricing remain key to making an astute investment. An example of this would be a building acquired in Albemarle Street, Mayfair in 2006 for £1,000 per square foot, which sold in 2011 for £2,000 per square foot (100% increase).
Conversely another institution over the same time horizon acquired an office building in Milton Keynes for £12m and sold five years later for £2m – an 84% fall in value. Hence the market as a whole can mask some huge discrepancies and is certainly not a “blanket buy”. You need to be discerning.
Owning outright
Once a charity has decided it would like to invest more in property, how does it do it? One option is to invest directly. This has the benefit of owning the property outright and being in complete control. However, direct property can be illiquid due to the long sales and marketing process compared with shares and bonds, plus managing the building and deciding the best time to sell might be responsibilities that a charity may wish to delegate.
Inexperienced charity property investors might also fail to maximise performance by exploiting all the potential opportunities, such as refurbishment, redevelopment or change of use. The fall in or total absence of income when this might be happening or when a tenant goes bust is also a deterrent for some charities. If a charity is focused more on total return then this may not matter, but if it is permanently endowed it may be more problematic.
Generally, owning directly tends to appeal to larger charities because they have the scale to afford a large diversified portfolio of multiple buildings let to multiple occupiers. This means they are insulated in the event of, say a tenant default on an individual property.
A second option is to invest in a separate account. This is similar to owning property directly but the main difference is that an existing portfolio or sum of money is placed with a trusted professional adviser who builds up, or manages, a portfolio on the investor’s behalf.
This has the benefit of delegating decisions to the adviser who can then be judged on strength of performance. This should result in a better service than merely using different advisers on an ad hoc basis as investors will have teams dedicated to their portfolios. Any dissatisfaction and the investors can re-tender the management mandate after a pre-agreed period.
Simplest way
Perhaps the simplest way to invest is by using property sector shares. For example, the shares in property companies or Real Estate Investment Trusts (REITs) - such as British Land, Land Securities and Hammerson - are available on the London Stock Exchange. The downside is that these shares can be volatile in line with stock markets generally and they also tend to be low yielding. REITs also pay stamp duty so this is not a tax efficient way for a charity to access the commercial market. But they are very liquid investments.
The fourth investment option is a pooled fund. This is a fund set up with the aim of “pooling” together multiple investors to gain economies of scale and increased purchasing power. It allows access to a much larger and diversified pool of assets than can be afforded by individual investors and provides access to professional management.
Common Investment Funds (CIFs), to which charities have access and which offer tax exemptions, are a subset of pooled funds. The main benefit of a CIF is exemption from stamp duty (which is normally levied at 4% on most commercial transactions), and there is no withholding tax payable either.
Better diversification
No investment portfolio should invest in one particular asset class. As charity investors look for better diversification in their portfolios after the financial crisis they should – and are – increasingly considering property, which has matured as an asset class. Investors increasingly recognise its attractive risk-return characteristics and the benefits of holding it in a diversified portfolio.
Charities in particular should appreciate property’s ability to provide real, inflation-beating income. But they should also beware of the market’s complexities and the importance of choosing the right underlying investments.
