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PROPERTY INVESTMENT SPECIAL - GAMBLING ON A FULL HOUSE

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Property provides a traditionally safe haven, but liability for environmental problems increases the risk for inves...
Property provides a traditionally safe haven, but liability for environmental problems increases the risk for investors, warns Lewis Williamson

The old adage that you cannot go wrong investing in property is still not a view held throughout the council pension fund community.

The sector which has outperformed in recent years has been equities. The surge in technology stocks meant the talk was all of 'clicks and mortar' rather than 'bricks and mortar'. But as markets have tumbled, many have predicted a return to investments built on more solid foundations. In uncertain times, gilts and bonds are traditional safe havens. But so too is property.

This year's PT survey of local authority pension fund investment in property - supported by CCLA Investment Management - found most funds do invest a part of their fund in property. But, in general, the amount invested as a proportion of the whole fund is quite low - the average level being a little over 5%.

This weighting is just a whisker above the figure recorded by a PT survey, conducted in February 2000. It seems little has changed despite the altered market conditions.

Two years ago, when equities were still surging ahead, the survey found councils saying they intended to increase their property weightings. But once again the WM weighting has refused to shift significantly. This is despite the

fact quantitative analysis of the relative risks and returns from different asset classes reveals an 'optimum'

pension fund portfolio should have 11-13% of its assets in property.

While recognising the quantitative case for higher weightings, many pension funds and their consultants have been reluctant to move too far from their chosen benchmarks. The reason for this can be seen in the survey responses to the question of why funds decide to invest in property.

By far the most popular reason is diversification of risk, which 65% of respondents gave as their main reason. Performance came a distant second, with 23%. Only 4% of respondents said their fund invested in property because of their asset/liability model. But perhaps, as the performance of equities becomes less of a surefire bet, property will become more popular as an asset class.

As CCLA director Matthew Parlour points out: 'If you look at it what people are suggesting for total returns for the next year, for property you're probably looking at 6% to 7% total return. If you look at other asset classes, such as gilts and bonds, interest rates are very low.

'The equity market is subdued. Estimates are in the 6-9% range - but probably at the lower end of that. So rather than investing in property to spread the risk, there's also a real case at the moment to invest in property because the return is going to be pretty reasonable.'

The survey shows this assessment has not gone unnoticed by local authority pension funds. Asked whether, over the next 12 months, they were more likely to sustain, decrease or increase their property weighting, nearly 69% ofrespondents said they would maintain the existing weighting. But significantly, a quarter said they intended to increase their property weighting.

However, there is a paradoxical element to property's outperformance over the past 12 months - because it has done well, it means funds are actually at the top of their current weightings. This then triggers benchmark warning lights which prevent further investment in property.

An expressed desire to invest more in an asset class which appears to be fairing well compared with equities may remain just a wish if the benchmark dictates otherwise.

Meanwhile, property unit trusts are by far the most

popular way of investing in property. This was the preferred method for more than half of respondents (51%) while direct investment was used by just over one in five (22%) respondents. This is perhaps a reflection of the difficulties in direct investment.

One issue thrown up by the survey is the increasing importance of environmental considerations when investing in property.

While whole forests have been sacrificed to provide the newsprint needed for journalists to write about ethical and socially responsible investment, very little mention has been made of this area in relation to property investment.

But as Mr Parlour points out, ethical considerations

are just as important in property investment as equity

investment.

'In a way it has even more relevance to property investment from an environmental point of view,' he says.

'For example, if you buy an industrial outlet and somebody has been storing chemicals there and the chemicals have been leaking into the local water supply. If you buy that property, you are liable to any fines that may come from the National Rivers Authority for chemicals leaking in to the water supply.'

Mr Parlour adds: 'We suspect people perhaps haven't considered the environmental aspects of property investment. So although everyone's talking about SRI, we suspect they haven't really thought about it in the context of their property holdings.

'You may get lots of people who are all-singing and all-dancing about ethical investment in their UK equity fund, but you may well find that if they invest in property, they haven't actually contacted their legal advisers about environmental issues.'

It is important councils are aware of the statutory responsibilities imposed upon owners, trustees, financiers and advisers in respect of any pollution emanating from property sites. Investments which are going to lead to legal action and fines do not seem like such a good bet.

But it appears local authorities are not totally ignorant of this side of things.

Some 62% of those holding a direct property portfolio having commissioned land-quality statements or similar environmental reports to ascertain whether any of their existing holdings can potentially result in environmental contamination emanating from the site. Of those investing directly in property, 100% commission an environmental report prior to acquiring new holdings.

But, as the survey graphics reveal, there is less than

universal confidence that legal advisers are aware of

their responsibilities in terms of advising on environmental issues.

There is widespread doubt as to whether managers of property unit trusts take environmental issues into account. It may be interesting to see whether future statements of investment principles begin to reflect such concerns.

Survey Results Summary

Does your scheme currently invest in property, either directly, or via a third party manager?

Of 22 respondents, 21 said they invested a total of£1.1 24bn in property. This amounted to an average figure 5.3% as a proportion of the total amount invested.

Yes 95%

No 5%

What was the main attraction to your scheme of property as an asset class?

Secure and rising yield 4%

Performance 23%

Asset liability model 4%

Diversification of risk 65%

Other (part of balanced mandate) 4%

How do you invest in property?

Property shares 13%

Limited partnerships 13%

Directly 22%

Property unit trusts 51%

Over the next 12 months are you most

likely to:

Maintain current property weighting 69%

Increase property weighting 25%

Decrease property weighting 6%

Are you aware of the statutory responsibilities imposed upon owners, trustees, financiers and advisers in respect of any pollution emanating from property sites?

Yes 57%

No 43%

Are your legal advisers aware of their responsibilities in respect of advising you on environmental issues?

Yes 55%

No 45%

If you invest in property via unit trusts, are you aware of whether environmental considerations are taken into account by the manager?

Yes 33%

No 67%

If you invest in property via an externally managed segregated portfolio, are you aware of whether environmental considerations are taken into account by the manager?

Yes 63%

No 38%

If you invest directly in property are your legal advisers raising at the time of purchase specific inquiries with regard to environmental issues?

Yes 86%

No 14%

If you invest directly in property do you or your advisers commission a land quality statement or similar environmental report to enable you to be aware of any environmental issue prior to acquiring new holdings?

Yes 100%

If you hold a direct property portfolio, have you commissioned a land quality statement or similar environmental report to ascertain whether any of your existing holdings can potentially result in environmental contamination emanating from the site?

Yes 63%

No 38%

Are you or your advisers considering the potential for you tenants to create environmental hazard which could ultimately result in a claim upon you as owner?

Yes 63%

No 38%

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