It is possible to invest in property without taking individual ownership of physical assets and the associated risks by dealing in property-related shares, where property investment funds are the most popular investment vehicle.
What are property investment funds?
Investors purchase units of a fund, with capital usually staying in the fund until such time as the properties are sold and the proceeds are distributed between a number of investors.
Property investment funds can include commercial, industrial, retail and residential property. They can invest in tangible properties or shares in property companies, or a combination of both. Funds that are invested in physical property are less liquid than those that invest in property shares.
Property funds and syndicates must typically be viewed with a long-term investment in mind.
Direct investment vs funds
Generally speaking it takes considerable resources to build and manage a diversified portfolio of property company shares. Furthermore, such shares do not normally represent the most effective way of investing in property due to company volatility and tax implications.
Property Investment Funds are normally operated by a professional investment manager and - depending on the fund in question - are likely to carry tax implications more favourable to the smaller private investor. In many cases property funds are SIPP compatible.
There are generally two ways in which to profit from property investment funds:
- Regular income: usually every six months and generated from rental income, known as distributions.
- Capital gain: on the original investment but only if the value has increased between the entry and exit points of the investment. Net proceeds are distributed between investors (the net asset value being the funds' assets, minus liabilities divided by the number of outstanding shares).
There are two main types of property investment funds:
Regulated (closed) property investment funds look to spread risk by creating a balanced portfolio of investments, generally holding lower risks for investors but also lower returns. There are stricter rules that regulated funds must follow such as:
- They must have an independent body or individual who will be held responsible for keeping the investments safe.
- They must be invested directly in property or property related assets.
- They must undergo an independent valuation according to the open market, at least twice-yearly.
Unregulated (open) property investment funds are only suitable for high net worth or sophisticated investors and are not marketed to the general public. They bring higher returns but also higher risk and less liquidity than regulated funds. Unregulated funds are not subject to the same restrictions as authorised or regulated investment funds.
The choice between investing in open or closed property investment funds will depend on the investor's risk/return profile. Unregulated funds are higher risk but will generate higher returns; regulated funds represent lower risk to the investor but will usually also generate lower returns.
There are both benefits and drawbacks to investing in property funds:
The main benefits to property funds are:
- Diversification - Property funds invest in a wide range of property sectors and geographical locations.
- Capital growth - As well as dividends profit can be gained in the long-term through capital growth generated from the properties in the fund.
- Professional expertise - The fund manager will be experienced in the property sector and will provide professional expertise when deciding on which properties to include in the fund.
- Hands-off investment - There are no requirements for the investor to be involved in the management of the property or employing a successful exit strategy (e.g reselling or renting the property).
- Some of the drawbacks to investing in property funds are:
- Lack of liquidity - Property funds are generally viewed as a long term investment, usually with a specific exit period, so it will be more difficult for investors to liquefy their investment if the capital is needed.
- Volatility - Depending on the type of property investment fund that is chosen (regulated or unregulated) risk to capital will be dependent on the value of the property at the time of exit.
What are REITs?
Designed to provide a similar investment structure for property as mutual funds provide for stock investments, Real Estate Investment Trusts (REITs) are property funds with tax exemptions if 90% or more of the profits generated are distributed to investors. They are managed as property companies and the income is paid out to investors rather than re-invested in property.
There are three types of REITs: Mortgage, Equity and Hybrid:
- Mortgage - The company purchases existing mortgages or mortgage-backed securities or loan money for mortgages to property owners. Revenue is generated from interest earned on mortgage loans.
- Equity - The company purchases, owns and manages income-generating commercial, industrial and residential properties. Investors can earn profit from dividends as well as capital growth.
- Hybrid - A combination of both mortgage REITs and equity REITs.
What are property investment syndicates?
Property investment syndicates allow investors to invest directly in property - typically with far less capital outlay than would be required if investing alone - by bringing together a group of investors to purchase a property or properties.
They are usually unlisted and involve a restricted number of investors and a specific amount of capital to be raised; syndicates usually invest in a single property or development of properties. This represents a higher risk than investing in property funds as there is less diversification and investors are exposed to only one market sector.
*This page is provided for information purposes only and should not be construed as offering advice. IPIN Global is not licensed to give financial advice and all information provided by IPIN Global regarding real estate should never be treated as specific advice.
- Wednesday 28 January 2015