The first question that is usually raised when discussing any property fund is that of liquidity. How quickly an investor can redeem their investment, and whether a fund manager is able to turn physical assets into cash quickly in order to meet redemption requests.
Liquidity is another area where the commercial and residential sectors differ quite considerably.
Residential - small lot size, large market:
The average lot size of commercial property assets held by a mainstream property fund in the UK is measured in millions of pounds. Commercial property lot sizes necessarily restrict the number of purchasers available and therefore finding purchasers for assets in periods when the market is under stress may prove difficult, particularly if debt funding is restricted. In such circumstances, commercial property funds have found it necessary to suspend redemptions for a period when it experiences sustained net outflows.
In contrast, the residential property market is much more liquid, due both to the far lower lot size and the fact that this asset class has both an investment and owner occupier market.
This graph demonstrates the significant differences between commercial and residential market transactions:
A property fund does tend to have liquidity advantages over individuals holding a handful of direct property assets. If the fund is well diversified, holding a range of different property types and in various locations, the fund manager can identify assets that will sell faster given the prevailing market conditions. The fund may also have a steady stream of rental income that can be used to meet redemptions in the short term, although a fund which employs a high degree of gearing may have less scope here should it be using rental income to service the debt.
As with any potential investment decision, investors or their advisers should conduct rigorous due diligence on the fund manager, the investment strategy, and the underlying assets to understand their liquidity management process, and the manager’s experience is in the market.
Sources: Our residential property total return is comprised of a capital return taken from the LSL Acad house price index (formerly the FT HPI) and an assumed constant gross income return of 5.5 per cent (4.13 per cent net) until 2008. The gross figure has been sourced from a GLA report, produced by Savills, and reflects a 20-year average. The net figure has been calculated by applying a 25 per cent discount to the gross return, reflecting the approximate costs of property management and maintenance in a large-scale residential fund able to benefit from economies of scale. By using a 20-year, rather than the higher 30-year average of 6.2 per cent, we are in fact presenting a relatively cautious view on historic total returns. From 2008, ARLA buy-to-let rent figures (gross) have been used and discounted by 25 per cent. The total return data for commercial property has been sourced from IPD, while equity and gilts data is from the 2012 Barclays Equity Gilt study. Performance has been calculated on a per annum basis, with 2011 (the latest available annual data) as the end-point