Property funds are coming out of limbo: here's what's changing

Property funds are getting a long-awaited shake up in a bid to keep this shrinking part of the market alive and increase appeal to investors in the long-term.

Most of us are familiar with investing in property through owning a home. Ideally, you’d get on the property ladder and, down the line, sell your house for more than you paid or rent it for extra income.

Putting money into a property fund is a way to access returns from this same principle. But in this case, the buying and selling is done by a manager who typically focuses less on residential property and more on non-commercial structures such as retail parks or office buildings. This is an ideal way to create some portfolio diversity in a portfolio that might also contain more traditional stocks, like tech or healthcare companies, which tend to be higher risk.

Anyone who invests in property funds or has considered it over the past few years may have been confused that the literal names of the sectors didn’t very accurately reflect what type of fund was in thereafter becoming a bit of a mixed bag.

This made it tough for people to compare and assess which property fund was right for them and one of the quickest ways to put someone off investing is for it to be confusing to understand.

To help fix this, the Investment Association (IA) – the trade body in charge of open-ended funds – has come up with new names and rules for property funds which should make this particular part of the market easier to digest.

Why have the changes been made?

As anyone who has ever bought or sold a house knows, the process can take a long time. This makes property an ‘illiquid’ asset, i.e. an investment which cannot be converted quickly into cash.  

Previously, this caused issues when accessing property via an open-ended fund as investors can take their money out of the fund any day, but the properties can’t be sold at this same rate.

Usually this isn’t an issue as fund managers will keep a certain amount of cash on hand to help payout any existing investors. But in 2016 when the UK voted to leave the EU, a lot of investors became worried and tried to take their money out of the UK market at a higher rate than usual.

This led to some investors not being able to access their cash when they wanted, because funds weren’t able to sell their property assets quickly enough to give investors their money back.

This started the ball rolling on the UK’s investing regulator, Financial Conduct Authority, trying to keep the property sector alive while at the same time, making sure that this type of liquidity mismatch didn’t happen again.

It began a review into how to solve the issue in 2017, which is still ongoing so, in the meantime, the funds themselves began to evolve to tackle this issue by becoming ‘hybrid’.

How are the funds changing?  

Many property funds are now taking a hybrid approach, which takes the traditional direct property investment route combined with investing in REITs (Real Estate Investment Trusts) to sort out the liquidity issue. REITs are a type of fund that’s classified as a company. They are listed on the stock exchange like any company would be, so their value is influenced by market demand rather than simply the value of the assets the trust holds.  

Aberdeen, which launched its first hybrid property fund in 2005 and was one of the first to convert their direct property fund into this new format, says “this hybrid structure addresses the evolving needs of investors who seek stability and flexibility. It’s particularly useful for UK investors who want international exposure and for global investors who are looking for enhanced diversification”.

How do you recognise these funds?  

The Investment Association (IA) has decided to recategorise its two property sectors to bring them up to date with the types of funds investors want and what asset managers are offering to them.

Currently funds fall into either the IA UK Direct Property and IA Property Other sectors but as of 1 June, they will be renamed the IA Direct and Hybrid Property sector, and IA Listed Property sector.

These are crucial for helping investors know where to look when researching investment ideas. Here’s what the new titles mean:  

IA Direct and Hybrid Property sector: Minimum 35% allocation to direct property, can invest globally and not just in the UK, and will need to have 70% of their assets in direct property or in a mixture of direct property and listed property securities.

IA Listed Property: Must invest at least 80% of their assets in listed property securities (REITs). This is where the more regional specific funds will live, such as ones only investing in UK or European assets. 

This might seem like a superficial change, but anything which helps give people clarity to make the best investment decision is a helpful switch, even if it's just a name.