Is Property Attractive for Pension Funds Investment?
The main property types that attract pension funds to invest are office property, commercial, and industrial. Pension Fund Investments do not tend to invest in residential property. Big Funds Company prefers direct property investment; whereas small funds prefer indirect investment through exempt property unit trusts (like the Pension Fund Property Unit Trust).
The main targets of direct property investment are the attainment of a safe rental income and an increment of capital value. Large funds tend to select their investments thoroughly to meet the latter objective, whereas small funds company look to be more engaged with the former.
Earlier, pension funds invested in property companies’ stock, but since early 60s they have begun to invest directly in property, preferably freehold property, but leasehold property with good capital-appreciation prospects is also acceptable. Direct investment offers more influence compare to both the type of property bought and the subsequent management of the property than does investment in property-company shares.
At first, property holdings were restricted to the United Kingdom, but with the ending of exchange controls in 1979, pension funds started investing in international property, especially in the United States.
In contrast with financial assets, real assets are differentiated by a large number of characteristics. The differences between the shares in two different companies are commonly rather small, but the differences between two buildings can be enormous. Hence, it is important to specify the set of characteristics underlying property investment. Property location, property design, property type and conditions of tenure are 3 of the most critical property characteristics. Of these, location is the most critical factor in deciding to let property into the market. If the building’s location is best, it can be let even if the design is lacking. Likewise, a building can become challenging to let because the centre of gravity of activity has changed in relation to its location.
A typical example is new shopping centre buildings, which reduces the popularity of a traditional shopping zone. Building design (internally and externally) also has an important influence on the price of rental values. This is because a poorly designed building or, just as important, a building with an out-of-date design, need to be restructured once again if it is to be let. Rental values also depend on the types and conditions of tenure: freehold or leasehold, rental review periods, nature and length of leasehold, and so on.
Offices, shops and industrial property have different factors that should be considered when planning the investment property portfolio.
Offices Property
With offices, the most fundamental factor for good investment is simple access for staff. More than one-quarter of UK workers work in offices, and 1/2 of these are in the Southeast. Proximity to transport routes has an important effect on rental values. Good design is also required, the most important factors being: modern and sound construction, good lateral and vertical communication, efficient heating and ventilation, flexibleness in conditions of use of space and adequate servicing, including computing and telecommunications facilities.
Shops Property
With shops, the most fundamental factors for good investment are: ease of access for customers and good storage and delivery vehicles capabilities. The location restrictions for shops are less severe than for offices, since profitable shopping sites are not confined to central urban locations. With shopping types ranging from hypermarkets down to individual units, the most important type, from the investment viewpoint, is the multiple-shop complex occupied by national chain-store tenants.
Specified features of such complexes that bring to the property or value are good customer access (e.g. car-parking facilities), good pedestrian flow, good tenant mix (e.g. cafeteria services attract customers to the complex), layout, good shape and upper-level access (rectangular units with wide frontage attract the most walk-in customers, while escalators and lifts are needed to attract customers to upper levels; atriums give a sense of openness, even though they are otherwise a waste of space) and good access by delivery, refuse and other services.
Industrial Property
Industrial property covers light-industrial premises, heavy-industrial buildings, and warehouses. Only the first and last categories make eligible investments for pension funds. Heavy-industrial buildings are in general purpose-built by the companies that intend to use them for production purposes. The main criterion for industrial property is the ease with which raw materials can be moved in and finished goods moved out. This suggests that light-industrial property and warehouses with good rail and road connections close to conurbations will make the most desirable investments for pension funds.
Given the heterogeneous nature of property, it is probably not surprising that the property portfolios of pension funds also tend to be very diverse. While many have a general mix of property, some concentrate on office and retail property, with yet others specializing in industrial property.
Some Advantages and Disadvantages of Property as Investment
Property has advantages and disadvantages compared with other investments vehicle. The main disadvantages are liquidity and management time and costs. Direct purchasing of property costs 5.5% (including stamp duty), while spreads with property unit trusts are 6-8%. The main rewards of property compared with other assets are assured income returns protected by upward-only rental reviews, low volatility of returns and low, or even negative, correlation with other assets, making property an excellent asset for diversification purposes.
Property is valued by discounting projected rental income. The discount rate used is typically linked to that of a high-quality corporate bond.