Some of the recent residential property fund launches merit examination.
Fund managers have the uncanny (but unwitting?) knack of calling the peaks of bull markets. And it's pretty easy to spot: they start issuing truck loads of funds focused on the most bubbling sector. Hence four times as many technology funds were launched in 1999 as in 1998, and a few years ago we had numerous launches of commodity and commercial property funds -- just in time for 50% plus corrections.
So it's quite interesting to see the number of residential property funds being launched recently. No one can say the property market is booming (outside of a few, bonus fuelled ghettos), so is this the exception to the rule? Are astute managers genuinely spotting a 'once in a decade' investment opportunity? And more to the point, if they have spotted an opportunity, do their proposed funds make any investment sense?
To answer those questions I've recently taken a look at two new funds. I've chosen them because as well as being the most recent, they each employ slightly different strategies that may appeal to different types of investor. But firstly -- what is the rationale for investing in property now?
They claim there are bargains are current prices
I'm not so sure. Nationally, prices fell about 20% from the 2007 peak to the April trough (which makes the big assumption that was the trough). Since then they have drifted back up in price but still remain below their peak. As an aside, here, I would caution against using a price index like the Nationwide at the moment. It is based on mortgage approvals, not actual sales, and in a thin market that can distort results. Far better to use the land registry figures which are based on the actual selling prices of the same house.
Estate agent Savills is saying that sales of property portfolios are selling at discounts of 20% to 25% to current valuations. Combine that with the falls in prices and some properties are being snapped up for 50% less than their 2007 price.
Furthermore, the decline in new developments is leading architects to suggest that there will be a substantial shortfall of new build units over the next six years.
Am I convinced by this kind of analysis? Not really. I reckon for property prices to rise people need to have both growing incomes and ready access to mortgages. Current and projected unemployment, and lender demands for large deposits, don't fill me with hope. Also, the National Housing Federation has recently said prices could rise by 20% over the next five years. Sorry? I can get that, with no risk, from a fixed building society deposit. Admittedly, the 20% excludes any rental income, so let's see how the two funds I've selected are structured, and how they reckon they're going to make us money.
The Residential Growth Partnership
Close Investments last month announced the launch of this fund which has a five year life and which will buy and let properties to the over 60s on a life tenancy basis. Tenants pay an upfront, declining proportion of the house value depending on their age, and the house will be bought at a discount. The fund is targeting a return of 8% a year (no commitments, mind) and aims to raise £15 million by its close date in December.
At the end of its five year life the portfolio will be sold and all proceeds paid out to investors as capital gain rather than income. Now that gains are taxed at 18% that's very handy for the 40% or 50% taxpayer.
Clearly, with a focus on life tenancies and discounted purchase prices, the fund is not totally dependent on property price rises, or finding 'distressed buyers'. The main risk is that the fund cannot find a buyer at the end of its life.
The cost of this expertise? Well, for starters an initial charge of 5% of funds raised and a 1.375% annual management fee. But just take a look at the performance fees. They are 20% of any IRR over 8% a year, and a mouth watering 35% of any IRR over 12%. And if it doesn't perform, how much is the annual management fee reduced? Guess what, it's not!
Dualinvest
A couple of weeks ago Smith and Williamson announced the launch of a closed end unit trust to be quoted and traded on the Channel Islands Stock Exchange, and managed by property specialists Wyndham York.
The fund will aim to capitalise on the demand for cheap financing from venders of property. Its proposition is quite different from The Residential Growth Partnership because it pays an upfront coupon to the investor and it will work in the following manner.
The fund will acquire a 65% interest in individual residential properties, from corporate venders. It then constructs a two year lease agreement which pays an upfront 13.5% to the unit trust investor (about 7%pa for the two years). The vendor is responsible for renting out the property and takes on any default risk. The agreement with the vendor can be extended for a third year, in which case the vendor pays 6.75% of the full property valuation. So the principle is that the unit trust acquires 65% of the property but gets 100% of the rent.
The fund will have a first recoupment position on realisation of the property, which safeguards investors from capital loss unless the sale proceeds are more than 30% lower than the original purchase price. At the time of sale, if there is a capital gain the vender's 35% stake gets them 85% of the gain, and the fund takes the remaining 15% of the gain. The fund will not employ borrowings.
Why I have my doubts about this kind of fund
I think both these offerings are pretty imaginative. But therein lies my sneaking suspicion. If buy-to-let (and both funds are a variation on that theme) is such an attractive investment proposition, why is there any need to go beyond a plain vanilla BTL fund, that buys properties, rents them out and delivers income and gains to investors? Possibly, just possibly, because on current prices 'plain vanilla' BTL funds don't make economic sense. And when simple things don't make sense, clever people wave intellectual wands and conjure up 'sellable' ideas. I'll keep an eye on these and other funds, but for the moment, I'm on the sidelines.
