Evercore Pan Asset

I used to like property investment. Prior to 2007 property did what I wanted. It was often less volatile than shares, but more exciting than bonds. The rental income was fairly reliable, and it often grew. Rents have to be paid before dividends when times get tough, and rent reviews often lead to higher rents in the good times. Property income can be mid way between interest on a bond and dividend on a share. UK property did well. Tight planning controls created artificial scarcity. Investors benefitted as a result.

I changed my mind in 2007. The likelihood of high interest rates and tough monetary action was bound to bring down property prices. The asset bubble had pushed property values up just as surely as it had pushed share prices up. When the US, UK and EU authorities all decided at the same time that the party was over, it was time to leave before the rush.

Usually if you buy property when it offers a higher income yield than you can get on shares or bonds, you do not go far wrong. We are back in such times, after the property collapse. In the UK you can obtain an initial income above 5% on a good quality property, at a time when a government bond is only offering a bit over 3% and an average share something similar. Asian and US property also offers better yields in many cases than government bonds or shares.

So what’s the catch? There are two main worries. Official interest rates will not stay as low as they are today indefinitely. US, UK and EU official rates are very low by past standards. Rising rates can be bad news for property.

However, investors should remember that interest rates are already a lot higher than official rates for property or business finance. There is a two tier market, where only the government gets to borrow at the ultra low rates. That gives investors some protection if and when rates start to rise.

Some also doubt whether rents can rise at a decent pace as they used to, given the slow growth that now seems to be the lot of the advanced economies. They are right to worry. There may be hotspots, but the overall results will be less exciting than in the past.

Property investment can be illiquid and expensive to manage. That’s why I prefer for many portfolios to buy Real Estate Investment Trust (REIT) shares. You have the benefit of a professionally managed portfolio and most of the rent flow. You can sell them quickly just like any other shares if conditions change or you change your mind. In return for this advantage you may not get as high a yield as on the underlying property. The substantial costs of managing property are of course taken out of the company revenues before you get your dividend.

REITs have some of the characteristics of property and some of shares. They enable you to buy into good real estate in faster growing parts of the world like Asia, where the starting yield is still quite good and there is likely to be some growth. They deserve a look for your portfolio.

As Published in Investment Week