Do property ETFs look attractive investments in the current climate?
Property ETFs, ones tracking the returns of the property sector of the equity market, have a number of general strengths to recommend them alongside some particular weaknesses.
First the strengths. If property companies or real estate investment trusts (REITs) are more like investment funds than ordinary businesses, property ETFs both be seen as a kind of fund of funds. The ETF is still an index-tracking investment but the risk spreading is across a broader range of property manager talent as well as across more of the market than investments in individual property companies.
Lack of choice is one problem
While property ETF total expense ratios are middle of the range at 0.4% to 0.6%, the real problem with using ETFs to track the property sector is relative lack of choice.
For example, for UK investors there are currently no total return ETFs available. REIT regulations require them to pay 90% of rental profits to investors, but a property ETF doesn't have to pass those dividends on to their shareholders; they could be re-invested.
If it was possible, many investors might prefer to invest in an ETF that tracks an index such as the DJ STOXX 600 Real Estate TR. Comstage ETF actually offer one such, but it's only listed on the Deutsche Boerse.
A second aspect of the lack of ETF choice is the absence of any ETFs for particular types of property. The reason for this is the specialist indices don't exist in the property company sector. FTSE has a range of indices for different types of property (retail, office and industrial) and these can be tracked by derivatives. Swap-based ETFs to track them could be developed but this will probably have to await a full-scale property upturn, as will a better choice of property ETFs around.
Concentration is the most serious drawback
The biggest problem with the few property ETFs available is the high level of investment concentration that they bring.
A look at the few property ETFs available in the UK highlights the problem. A £3,000 investment in the iShares FTSE EPRA/NAREIT UK Property Fund (IUKP) would currently concentrate over £1,800 (61%) in just four companies: Land Securities (LSE: LAND), British Land (LSE: BLND), Hammerson (LSE: HMSO) and Liberty International (LSE: LII).
iShares FTSE EPRA/NAREIT European Property Index Fund (IPRP) avoids those FTSE 100 constituents as its excludes the UK but concentrates 26% of your investment in the giant French REIT, Unibail-Rodamco.
The best ETF for avoiding this level of concentration is iShares FTSE EPRA/NAREIT Developed Markets Property Yield Fund (IWDP) but it only manages to do so because a mere 20% of its constituents are from the UK or continental Europe compared to the 35% comprised of US constituents. The 'yield' in the name signifies that 'dividend plus' version of FTSE's index is being tracked.
What about property assets?
Since the early March low point, the iShares UK property fund has outperformed the FTSE 100 by a margin of two to one. That said property had fallen a lot further than most other assets in the preceding two years; the iShares UK fund was down almost 80% from March 2007 to March 2009. The iShares European and Developed Markets Property funds fared less badly, partly because the fall in sterling worked in its favour.
Dividends (rental profit) are the main underpinning for REIT and other property company share prices and these could fall either because occupancy rates and rents fall or because of higher interest charges. However, this support for property share prices isn't likely to suffer serious collapse.
The question of property's growth prospects seems more problematic. Is there going to be a fully fledged recovery of the property market that will make current share prices look like bargains in a year or two? Investors have faced down the talk of a dead cat bounce and, latterly, of a bear market rally, but property could miss out on the recovery to a significant degree.
For those who take a cyclical approach to asset allocation, property should come back into favour as the recovery gets going but, if the next six months are going to see the early stages of the recovery, there are not many signs of growing interest in property to accompany it. So, in these respects, it could be years before we return to the confidence of 2006.
So on balance, I remain wary of property in general and property ETFs as a way into property assets in particular.
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