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The long and the short of Reits

Real estate invest-ment trusts will be introduced to the UK market next January and IFAs are getting to grips with the impact on the property invest- ment market.

Property, primarily through unit trusts, has been one of the top-selling asset classes for the last couple of years but, given the fact they have been largely marketed as a diversifier, will this still hold true with Reits, which are, after all, listed vehicles.

Scottish Widows Investment Partnership pan European property fund manager Nigel Bolton does not believe that a closer correlation is likely due to the Reit structure and thinks volatility will be reduced as a result of the new vehicles.

He says: “The US market has a 40-year history of Reits and has always shown a low correlation between property and equities. We are expecting a transformation to be more correlated with direct underlying property assets.”

Bolton also cites Swip research on the 15-year-old Dutch Reit market compared with the UK quoted property sector which shows that the volatility of the UK sector is around 50 per cent higher than its Dutch equivalent.

He says: “We believe the introduction of Reits will lead to much lower volatility in the UK.”

Bolton says Reits are one of two key drivers making property a hot asset class in the UK and Europe.

He says: “European real estate remains strong because valuations are being pushed up due to the high yields from property which bring in the big flows of international money but the second driver is the creation of Reits in the UK and Germany as companies become tax free.

“Historically, real estate provided no yield but in 12 to 18 months, income funds will start to look at property.”

Seven Investment Management director Justin Urquhart Stewart says IFAs are likely to look at selling Reits on an individual basis, which will have good and bad consequences for investors.

He says: “They will be positive because it will mean greater diversification but it could be bad because some IFAs may look at dealing with smaller Reits which could lead to an increase in risk.”

Premier Asset Management pan-European property senior fund manager Alex Ross believes the adoption of Reits by investors should be viewed as a trade off between short-term volatility for longer-term profits.

He says Reits are an equity product, so investors need to be aware that they will always have a higher correlation with equities than their direct property counterparts.

Ross says: “They will always have higher volatility compared with the FTSE real-estate sector but it will reduce by about a third. They have a higher correlation to equities and gilts but they will give investors access to gearing and high-quality management.

“Reits are equities but fully asset-backed. They are attractive because investors are tapping into the best quality assets.”

Ross believes that many intermediaries will promote Reits as total-return vehicles.

He says: “UK Reits will be seen by many as total-return vehicles, similar to the French model which yields about 4 per cent, but investors will also get capital growth. If investors can accept the short-term volatility of Reits, they will always have a place in balanced portfolios. There should always be a balance between direct and indirect property.”

Skandia chief investment officer Alan Durrant says a correlation between property and equities has many positive benefits as property and equities give investors access to huge companies which are broken down into manageable chunks.

Durrant believes that in the longer term, how property is packaged will become irrelevant as the returns will be broadly the same.

He says: “Reits give the tax-efficient structure so investors can trade in them. The biggest problem with direct property has been that a fund manager may want to focus on one area such as the London or French property market but may find that the market is too illiquid. With a Reit, the shares will be listed and it will be easier for investors to take a view. “

Durrant says there is huge interest in Reits from IFAs despite the heightened potential for short-term stockmarket setbacks.

He says: “Few people invest in the stockmarket on a six-week view. After a market setback, Reits may be more volatile than bricks and mortar funds which are reviewed on a rolling basis.”

He believes that direct and indirect property have their attractions as part of a diversified portfolio and considers that Reits have created a landmark for UK investors.

He says: “Ten or 20 years ago, investors diversified their equity and bond exposure away from the UK and now they will be able to do it with property. It is rare for a genuinely new asset class to come along – the last one was probably corporate bonds in the mid-1990s.”

Durrant believes many IFAs will not have the resources to look for individual Reits for their clients and the majority will choose to use specialist fund firms which have a greater depth of property research.

Merrill Lynch Investment Management head of in-direct real estate John Gellatly says Reits will bring down volatility, citing the US and Australian reit markets as examples. He says: “Volatility there is much lower than the wider equity market because Reits are generally lower leveraged and defensive stocks. However, this means the correlation of Reits to equities will be higher.

“On a scale of one to 10, UK real estate volatility is about 10. Reits will bring it down four or five but they will still be more volatile than bricks-and-mortar funds and still less than other equities.”

Gellatly believes major fund houses will be looking to launch Reits over the coming months. He says: “In overseas markets, Reits are good products to have in pension plans. They are a reliable complement to equities and deliver a high coupon.”


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