Issue: April/June 2010
Liberty Corporate

Realities of real estate

Lauren Billett, head of investment products at Liberty Corporate, looks at the merits of unlisted property portfolios and suggests why retirement funds should consider investment in them.

Brandon Furstenburg

Billett...properly in property

Investment in property as an asset class strengthens diversification of a retirement fund’s overall portfolio. This asset class generally has a low correlation to the other major asset classes – equities, bonds and cash – because the property cycle does not necessarily move in line with these other markets.

Two types of property investment are available to retirement funds; listed and unlisted property investment.

Listed property investment takes the form of purchasing shares in JSE-quoted property funds. These funds are priced by the stock market and are therefore subject to similar potential volatility as other equities.

Unlisted property investment is best suited to the investor who wishes to reduce correlation with equity markets but is still aiming for inflation-beating returns over the longer term. Unlisted property investment can take the form of purchasing units in professionally managed institutional vehicles, or as the direct purchase and administration of buildings by the retirement fund.

Direct purchasing of buildings and land is likely to be limited to the very large retirement funds for whom the illiquid nature of the investment does not pose a problem. Diversification within the property asset class is also difficult to achieve using this method due to the large sums involved.

A clear advantage of unlisted property portfolios is that they allow investors such as retirement funds to access the diversification benefits of the asset class – without taking on the risk of purchasing an actual physical asset and holding it on the balance sheet.

In addition, these unlisted property portfolios generally offer the liquidity of a market-related portfolio, although there might be some termination constraints.

Due to the nature of the valuing and pricing of the unlisted property, which generally happens annually or quarterly as opposed to the daily pricing of listed property shares, there is lower volatility than with listed shares. Also, compared with listed property funds, there is limited gearing in the unlisted investment. This also acts to reduce the level of volatility compared with the listed investment.

Returns are generated through:

  • Receipt of income in the form of rentals;
  • Appreciation in capital value of the physical properties over the year.

Returns may be smoothed due to the nature of the valuations process. This process reduces the uncertainty of the investment value during the smoothing period.

Importantly, unlisted property-investment returns can be enhanced by the skill of the property manager in efficient handling not only of maintenance and refurbishments, but also in negotiating and securing tenancy arrangements. Retirement funds generally do not have the necessary skills to carry out this function internally.

Typically, these portfolios include a full spectrum of rent-producing commercial buildings: retail (e.g. shopping centres), office blocks, industrial complexes (factories), hotels, parking garages and conference venues. Some might have a residential component (apartment blocks) too.

Inclusion of other asset classes, notably cash and listed property, will make up the balance of the assets in an unlisted property portfolio. These other asset classes are included primarily to provide liquidity.

Capacity in this kind of investment portfolio might be restricted by limited availability of quality physical stock. From time to time, therefore, new investment might be capped. So when opportunities arise to get in, they’re definitely worth considering.

Depending on the time horizon, experience suggests that unlisted property can not only outperform other major asset classes but is likely also to outpace inflation over extended periods.