The Pros and Cons of Investing in Direct Property

VIDEO: Investing in property can help diversify your portfolio, hedge against inflation and generate income, but there are inherent risks to this illiquid asset class too

Holly Cook 12 June, 2012 | 4:44PM

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Threadneedle UK Property Trust
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Holly Cook: Here at Morningstar we've been looking at the property sector recently and I am joined by investment research analyst Simon Molica to go through the ins and outs of investing in this area.

Simon, thanks very much for joining me.

Simon Molica: My pleasure.

Cook: So we are talking about UK direct property today, what exactly is it you’re buying if you're buying in this area?

Molica: So UK direct property means bricks and mortars. So, if you're to cycle through the City, you would see the office blocks surrounding you, that's the type of properties that the fund managers are buying and building exposure to.

Cook: So what are some of the characteristics of this area? What role would it play in a portfolio?

Molica: So, if we look at the longer term returns over 10, 15, 20 years, the returns are very attractive both from absolute and relative point of view, from relative I'm talking about against global equities and bonds. It also and maybe more importantly offers you low correlation characteristics, which is helpful when building portfolios. Among other features are a partial inflation hedge and income is an important aspect to the asset class as well.

Cook: Okay. So direct property can be a diversifier and an inflation hedge and a source of income as well.

Molica: Yes, very much so.

Cook: So how about some of the risks that are associated with investing in this sector?

Molica: There are large risks associated in the sector. If you think of a property, it is an illiquid asset class, and these funds are open-ended daily dealing structures. So there is a mismatch there and you do need to be careful. The fund themselves need to be wary of heavy cash flows, so that's in or out. In the instance of inflows, it means they need to increase their property exposure, but they do need to be doing this at obviously the right price; and in the instance of outflows, it could mean potentially having to sell a property to meet your redemptions, and of course this could take time.

Cook: Okay. So let's assume that an investor is aware of the potential return, they are aware of the potential risks; give us a bit of information about what's been going on recently and what the outlook is.

Molica: Okay.So over the last 18 months the returns have been a bit steadier from the asset class. There is still a polarisation between primary and secondary properties and when we talk about primary we mean the best properties with the highest kind of tenant covenants. So the polarisation does remain and consensus seems to be that primary will continue to perform mediocre, while secondary will have further significant falls over the short term.

Cook: Okay. So are there any funds that are amongst your favourites that investors could take a look at?

Molica: It's a strange sector being that it is built of 10 or 15 different funds that are all very built of credible management teams. The fund houses themselves invest a lot of money into the asset class, and they normally build teams, built of a lot of individuals and with different specialist knowledge, which the managers themselves can access. One fund I would say is the Threadneedle UK Property Trust, which is a little bit higher risk and looks to invest in higher quality secondary assets, so it should probably be invested alongside a more prime-natured fund like the M&G or Legal & General's fund.

Cook: Okay. Well, thanks very much for these insights.

Molica: My pleasure.

Cook: You can find more information on the Threadneedle fund that Simon's highlighted, as well as some other favourite funds in this sector, below this video. Thanks for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author Holly Cook

Holly Cook  is Managing Editor of