David Prosser explains the benefits of the closed-ended investment company structure for investing in property.
Clichés can be misleading. When it comes to saving for the future, it’s easy to be lulled into a false sense of security by the widely held view that property is “as safe as houses”. But investing in property carries risks of its own – and even more so if you are not careful about how you invest.
Nevertheless, the fact is many Britons see property as the long-term asset that has the greatest potential to provide them with a decent return. New data just published by the Office of National Statistics shows that for those people who do not have access to an occupational pension scheme at work, property is regarded as the safest way to invest for later in life by twice as many as any other investment. They would far rather invest in property than in the stock market, cash savings or a personal pension plan.
Tangible but impractical
If that’s you, it is important to pursue your savings ambitions in a way that mitigates risk as effectively as possible. Buying bricks and mortar feels like making an investment in something tangible, but unless you have the budget to buy different types of property in different parts of the country, there is a risk you will put all your eggs in one basket. House prices can fall as well as rise, jeopardising your long-term wealth – plus you have all the hassle of managing your property in the meantime.
In fact, amongst professional investors, commercial property such as office blocks, retail units and industrial assets is more popular than residential homes. But while such property can help you spread your bets, making direct investments in such assets is out of the question for all but the wealthiest of savers. The upfront cost is simply too high.
In other words, while buying something you can actually touch may feel like a safer option than a more abstract investment, the practical barriers to doing so sensibly are too high for most of us. Buying a single buy-to-let property, say, is too narrow and risky. Buying a broader portfolio, or moving into commercial property too, is out of reach.
The collective approach
In which case, a collective approach to property makes sense – investing in property alongside others through a professionally-managed fund. There are lots of different property funds to choose from, offering exposure to all sorts of underlying assets, and investing in this way makes it easier to spread risk across a portfolio of holdings, rather than a single building.
However, here too you need to tread carefully. Most property funds are open-ended – they increase or reduce in size according to whether investors are putting money in or taking it out. When it comes to assets such as property, which can be difficult to sell quickly and easily, this structure can cause problems. When many investors want their money back – during a market crisis, for example – the fund manager may be forced into selling property too cheaply, which will disadvantage long-term savers. Or they may decide to suspend withdrawals from the fund, which prevents people getting their money out for a time.
There have been so many incidents of this type that financial regulators are currently working on new rules to address the issue. One suggestion, for example, is that investors may have to give six months’ notice of withdrawals from open-ended property funds.
For this reason, an investment company will for many people offer a better route into property. Investment companies are “closed-ended” – they’re fixed in size and savers invest or exit by buying or selling the fund’s shares on the stock market. This means the fund manager is never under pressure to sell holdings or to manage the properties the fund owns with this in mind.
What this does mean, of course, is that you’re investing on the stock market rather than in physical property. But ironically, given many people’s anxieties about shares, this is very often a safer option.