Property ETFs are more liquid but can also be much more volatile than direct open-ended property funds.
Property is seen by many as an important diversifier to hold alongside shares and bonds.
However, there has also been lot of negative press surrounding open-ended property funds, one of the more popular ways for investors to gain exposure to this asset class.
Like open-ended equity funds, open-ended property funds allow investors to add or withdraw money on a daily basis. In an open-ended fund, when an investor buys into the fund, the fund manager uses the money to invest. But, when an investor withdraws money, the fund manager sells a portion of the assets to return the money to the investor. This usually works well enough with shares or bonds, but property is an “illiquid” asset class, which makes this much harder. Property cannot be sold on the same day in the way shares can.
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The worst-case scenario for an open-ended property fund is when a large number of investors try to sell out of the fund all at once. In the case of an equity fund, this would simply mean selling shares. However, property cannot be sold so easily or quickly. As a result, in times of market panic, such as after the 2016 Brexit referendum or during the Covid-19 pandemic, property funds have had to “gate”. This means that investors are no longer able to withdraw their money. They are locked in.
One solution to this problem has been for open-ended property funds to have a cash buffer. If a portion of the money from investors is left in cash, it becomes easier for the fund manager to return cash to investors. However, this has its own drawbacks. As Henry Cobbe, head of research at Elston, notes: “Following a history of gatings when the going gets rough, property open-ended funds are holding much more cash, and also holding listed property securities as a liquidity buffer.”
At interactive investor, we prefer the closed-ended investment trust structure for property. Trusts have a fixed level of capital, so they do not need to sell the properties they own. Instead, investors who wish to sell simply dispose of their shares. As a result of this, property trusts offer greater liquidity and can be fully invested without concerns over liquidity.
The pros and cons of ETFs for property
Another option is exchange-traded funds (ETFs). Property ETFs track an index comprised of exchange tradeable Real Estate Investment Trusts (REITs) and property companies. Therefore, they provide diversified, liquid and low-cost exposure to real estate.
For example, an investor looking to gain UK property exposure could use the iShares UK Property UCITS ETF (LSE:IUKP). It tracks the FTSE EPRA/Nareit UK Index and its biggest holdings include well-known names such as Segro (LSE:SGRO), Land Securities (LSE:LAND), British Land (LSE:BLND) and Tritax Big Box (LSE:BBOX). It has an ongoing charge of 0.4%.
Another popular property ETF is the iShares Developed Markets Property Yield ETF GBPH Dist (LSE:DPYG). This tracks the FTSE EPRA/Nareit Developed Dividend + Index for 0.64%.
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Investors can also use index funds to track a property index. For example, on the interactive investor Super 60 list is the iShares Global Property Securities Equity Index (UK) D Acc. This has a fee of just 0.17% and tracks the FTSE EPRA/NAREIT Developed Index of around 340 of the largest REITs in developed countries.
Cobbe argues that ETFs or index funds are a preferable way to gain exposure to property. He says: “Property ETFs hold listed property securities - companies such as British Land Securities plc, but from all over the world. That way you are gaining exposure to property as an asset class in whichever region, or globally, but in a highly liquid and transparent way.”
Nicholas Maunder, an investment analyst at Canaccord Genuity Wealth Management, however, points out some potential downsides. First, he notes that property ETFs tracking an index often end up with highly concentrated exposure.
He explains: “Often the index will be constructed using a ‘market capitalisation weighting methodology’. This is an index construction methodology where individual components are weighted according to their relative total market capitalisation. Critics say that these are weighted towards larger companies in the sector and gives a distorted view of the market.”
Maunder notes that a positive aspect of a market cap weighting is that it helps to ensure there is liquidity.
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Another downside, according to Maunder, is that property ETFs can be much more volatile than direct open-ended property funds. He says: “For example, in the first quarter of 2020, the iShares UK Property UCITS ETF lost 27.6% versus -1.0% for the Morningstar–Property, Direct UK category average and -25.1% for the FTSE All-Share Total Return Index.”
Cobbe takes a different view. He argues: “Some say that property ETFs appear more volatile than property open-ended funds. In my view, that's a function not of the riskiness of the underlying asset class (they both have the same fundamental risk-return exposures: land values, rental yields, occupancy, leverage), but more a function of how and when the net asset value of the fund is valued.
“Property open-ended funds use valuations of physical properties prepared by surveyors/auditors from time to time. Property ETFs, however, reflect the second-to-second valuation of listed property securities. One appears more volatile simply because of the higher frequency of valuation. The economic exposure is basically the same.”
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