3 January 2014

Retail investors in real estate

No one likes to be called “ordinary”, but the Financial Conduct Authority (FCA) defines the vast majority of investors as Ordinary Retail Investors. So what, you might say. How does this affect
me? The answer becomes more pertinent after 1st January 2014. As a result of the FCA’s new policy statement 13/3 or the snappily named “Restrictions on the retail distribution of unregulated collective investment schemes and close substitutes”, Ordinary Retail Investors will no longer be eligible to invest in non-mainstream pooled investments. The purpose of this policy is to protect all retail investors (investing on their own account), except for those categorised as either sophisticated or of high-net worth, from complicated, illiquid or otherwise inappropriate investment.

However, change does not come without a price. In the past, with good advice, ordinary Retail Investors could still benefit from some non-mainstream investments, such as syndicated commercial property. This allowed investors direct ownership of commercial property. Returns were exactly correlated with the underlying performance of the property and investors could select the properties in which to invest, but investments were long-term and could be relatively illiquid.

As from the 1st January new opportunities for non-mainstream pooled investments, such as syndicated property will all but dry up for retail investors. Despite this, demand for property investments which provide a strong correlation with the underlying performance of the assets will remain.

For over ten years, Mattioli Woods has provided clients with opportunities for ownership of commercial property through syndication, both directly and, more recently, through Custodian Capital. Properties were selected to provide the appropriate risk and returns for long-term pension scheme investors. The model was principally designed around an income-based return, to build pension assets in the medium term in order to provide long-term retirement income. Limited liquidity was available through investors being able to sell their syndicate holdings to new or existing investors at net asset value. However, the restrictions imposed by policy statement 13/3 will reduce and could extinguish this liquidity.

Real estate market

What are the options for retail investors looking for real estate investment? Before answering that question, it would be appropriate to consider the rationale for real estate both as part of a balanced investment strategy and in the context of the current market.

Commercial property values are improving across the UK. The recovery that began in London in 2010, faltered in the regions throughout 2011 and 2012 and has now resumed in earnest. Unlike in 2010, when the property market was correcting following the extraordinary falls witnessed in 2008/9, the economy is out of recession and growing, with the prospects for the future looking better, if still a little fragile. In terms of detailed property market dynamics: a period of very limited speculative development has left an acute shortage of modern buildings; lack of supply is leading to rental growth across office and industrial markets, correcting a five-year slide in rents; retail markets are stabilising, with retailer administrations slowing and the stronger high streets and shopping centres re-establishing themselves as destinations for the nations favourite past time; property fund managers are seeing huge increases in flows of money into their funds; many listed property shares are trading at a premium to net asset value; many asset allocators are up-weighting in property; interest rates are remaining low and the high income yield from property is looking relatively attractive.

However, the property market is not a one way ticket, but it is a more compelling prospect than it has been for some time, as the drivers of growth are rooted in general economic recovery and the returns relative to other asset classes look appealing. The key to getting the maximum benefit from any property investment strategy starts with timing and thereafter it is about matching the natural return profile of property with expectations.

The perfect time to invest is normally only evident after the event, so if the broad indicators are positive, as discussed above, then investment in property should at least be an option. As to matching expectations with the natural return profile of property, investors should target income, long-term capital appreciation and careful stock selection. At its most basic, no-one has ever won Monopoly by trading in and out of properties. The board game is won by buying well and holding to collect the long-term income.

Real estate investment opportunities for retail investors

Few investors can afford a portfolio of directly owned commercial properties. As discussed above the opportunity to invest through syndication is to be heavily restricted. In the current regulatory
environment the options for retail investors are split between open ended funds, closed ended funds or property equities:

Open ended funds

The open ended or retail funds, which were so popular in the early noughties, are typical of those run by some of the well-known financial institutions.

Investors may not wish to expose themselves to these funds which have struggled over the last five years to deliver positive total returns. However, these funds are seeing strong flows of new money and will probably deliver some useful performance over the short term. Unfortunately, the very nature of the funds which are permanently open for investors tends to remove the investment strategy from the fund manager into the hands of supply and demand. When markets are running hot and demand for property is high, inflows of capital compel the fund manager to buy property assets. Conversely, when the market falls, and investors wish to redeem, the consequential outflows of capital force the fund manager to sell. In extreme circumstances, such as the crash of 2008, some funds sold up to 30% of their property, at rock bottom prices, to meet the demand for redemptions. This strategy can never deliver the returns required by long-term investors.

Closed ended funds

Closed ended funds are most commonly publicly listed on a recognised stock exchange. These funds are deemed to be “closed ended” because they have a defined portfolio of properties with a fund management strategy and the ownership is limited to the shareholders in the fund at any given moment.

Changes in demand for investment in the fund lead to movements in the share price and share trading, but does not alter the underlying make-up of the portfolio or necessarily lead to a change in portfolio strategy.

While this can lead to short-term volatility in share price, over the long-term the share price is very strongly correlated with the core performance of the property portfolio.

The chart below demonstrates how the selected closed ended funds performed against IPD total return (the UK commercial property market benchmark index), when compared to three of the largest open-ended funds whose performance struggled in the face of significant redemptions through 2008/9.

Property equities

Property equities can be bought either directly or via pooled funds. These funds may well include some of the closed ended funds described above and, in many ways, there is only a subtle distinction between the shares of a listed property company and those of a listed property fund. To add to the confusion, both could benefit from the tax transparent status of a Real Estate Investment Trust(REIT). Perhaps the simplest distinction is in the management of the business. A listed property fund tends to be managed externally by way of a fund management agreement (e.g. F&C Property Trust)while a listed property company tends to be managed by its own internal management (e.g. British Land). The rationale for investing in a particular listed property equity may well be to benefit from the discrete strategy of the company, for example Great Portland Estates who have a strong focus on central London.

The skill in selecting appropriate property equities lies in an in-depth understanding of the strategy of each of the property companies, their portfolio and a belief in the ability of the management to deliver the stated strategy.


Being “ordinary” does not mean investors must settle for ordinary returns. There are some interesting opportunities available to the retail investor in real estate. As always a balance must be struck
between, risk and return and between short-term and long-term strategy. For the experienced stock picker with a keen eye for market timing, there have been some exceptional opportunities in listed property equities over the last twelve months with returns of 20% plus.

For long-term investors with a desire for income, some of the closed ended funds have proved to be defensive over the long-term, recovering value lost in 2008/9 while consistently delivering 5% plus income returns.

Importantly, all the options available to the retail investor provide diversification, liquidity and transparency. Even some of the open ended funds could offer an interesting short-term position for investors.

Richard Shepherd-Cross