ETFs: A Better Way to Invest in Commercial Property?

Rather than investing directly in the underlying assets, property ETFs invest in the equity of real estate companies and Real Estate Investment Trusts (REITS)

Kenneth Lamont 5 October, 2016 | 9:01AM
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This article is part of Morningstar's Guide to Passive Investing, helping investors make smart choices to meet their long-term investment goals.

In their quest for yield many investors have turned to commercial property funds to help meet their needs. However many may be unaware that index funds and ETFs offer a highly liquid, low-cost and broad exposure to the asset class.

Rather than investing directly in the underlying assets, property ETFs invest in the equity of real estate companies and Real Estate Investment Trusts (REITS) listed on stock exchanges. The largest REIT in the UK is Land Securities Group (LAND) which owns and manages a string of high-profile commercial properties such as the ‘Walkie Talkie’ skyscraper and the iconic Piccadilly Lights in Central London.

Property Funds Feel the Brexit Affect

The liquidity benefits of investing indirectly in property became starkly apparent this summer, when in the wake of the Brexit vote, a slew of high-profile direct property funds run by Aviva, Henderson, Standard Life, Columbia Threadneedle, Aberdeen, Canada Life and M&G were forced to temporarily suspend all redemptions.

Over this period, UK-focused ETFs such as the iShares UK Property UCITS ETF (IUKP) continued to trade throughout the day without interruption, albeit with wider spreads than we would expect in ‘normal’ market conditions.

As we have come to expect of passive funds, the fees charged are much lower than their actively managed peers. While not exhaustive, there are a range of low-cost passive funds offering diversified exposure to developed Europe, the UK, the US and global real estate. For example, the BlackRock Global Property Securities Equity Tracker Fund offers global developed market exposure for an annual fee of just 0.21%.

Property ETFs Deliver Income

The income-hungry investors that have turned to passive property funds, and in particular dividend-screened property strategies over recent years have not been disappointed. The iShares Developed Markets Property Yield ETF (IWDP), which screens on one-year forecast dividend yield, has swelled to become the largest strategic beta fund in Europe.

Its attraction is understandable when we consider that it has returned a dividend yield higher than the MSCI World Index in every calendar year since its launch in 2006. While MSCI World has returned an average annual dividend yield of 2.2% over the period, the iShares fund has returned and average of 3.7%.

This popularity has attracted new market entrants such as the L&G Global Real Estate Dividend Index fund, which employs an identical strategy, but charges an annual management fee of 0.20%, a third of that charged by the iShares fund.

Investors: Mind the Volatility Bump

The passive indirect approach for accessing property investments is not without its drawbacks. For example, when investing in listed-equity, the investor gains liquidity but simultaneously assumes additional stock market risk. This tends to increase both the volatility of returns and the correlation of the investment with the wider equity markets.

A second major drawback is that listed property firms, and in particular REITs, tend to be highly leveraged. This further increases the volatility of returns and, due to the inverse sensitivity to lending rates, erodes some of the potential inflation-hedging benefits commonly associated with property as an asset class.

 

 

 

 

 

 

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.

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About Author

Kenneth Lamont  is a passive funds research analyst for Morningstar Europe.