Take Care with Property Funds

Investors can now choose between active or passive funds and direct or indirect property fund investments - but investors should be aware of liquidity risks

Gordon Rose, CIIA, CAIA, 13 January, 2014 | 4:20PM
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Investing in property through REITs, real estate mutual funds, ETFs, and private offerings has become significantly easier in recent times. This is particularly so since ETFs came to Europe at the beginning of the millennium. Consequently, investors can now choose between active or passive funds and direct or indirect property fund investments. While indirect passive property funds are nothing more than listed equities; a sector fund so to speak, active and direct investments are a little trickier.

Firstly, there is the liquidity mismatch: mutual funds typically offer daily redemption, while the underlying real estate assets are highly illiquid. Valuations are another problem. Real estate valuations are based on estimating the market value of a property and should reflect the price at which an informed investor is willing to buy or sell it.

However, properties are usually not traded for years and hence they are either typically valued using the income approach - discounted cash flow approach, or comparable sale prices. Meanwhile, properties where the value is driven by the actual business use of the real estate are valued using the profit approach. However, it must be noted that the correlation between an appraisal-based index and a market-based index shows no consistently positive or negative correlation, ranging in some regions between -0.30 and 0.30 over the last 20 years.

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About Author

Gordon Rose, CIIA, CAIA,

Gordon Rose, CIIA, CAIA,  is an ETF analyst with Morningstar Europe.

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