Property funds enable potential commercial property investors to partially own commercial buildings such as offices, warehouses, factories and retail units.
Here Prideview explain the key types of property funds and how they work.
Property Fund Options
Some property funds invest “directly” in commercial property – they buy actual properties including offices, shops, factories and warehouses.
Money is pooled or collected and a professional manager collects money from several investors, then invests the money directly in property.
This type of fund, also known as investing in “bricks and mortar” spreads risk by investing in several different properties while returns come from a mixture of rental income and capital growth.
An alternative to direct funds are “indirect” funds – meaning that instead of buying properties, investors buy shares in property companies or other property funds.
Instead of making money by capital growth and rental income, returns are gained through share price appreciation and dividend income like any other investment in shares.
This means investors don’t have the liquidity problems of direct commercial property funds and can move in and out of the fund freely.
Both direct and indirect types of fund are usually unit-linked. This means that they are divided into units, with each unit representing a share of the underlying investment pool.
Consumers buy a certain number of units, and the unit price will change over time to reflect the value of the underlying assets.
The funds are sold as general investment products and as part of pension plans. They are usually managed by pension providers, investment companies or life assurance companies.
Investment trusts that invest in commercial property are closed-ended which means they don’t have to sell properties when investors want to withdraw their money.
However, the share price of the trust will rise and fall according to investor demand.
This type of fund lists on the London Stock Exchange.
Sometimes investment trusts will trade at premiums to their underlying assets. At present, many are trading at discounts to their underlying assets.
Property funds can differ from other “collective investment” funds because there can be lengthy delays between a consumer asking to withdraw money from a property fund and that money being paid out, and the pricing of the units can be quite difficult to understand.
Advantages Of Investing In Commercial Property Funds
Investing in commercial property as opposed to residential property can bring several advantages.
Rent default rates for commercial property tend to be lower than for residential buy-to-let property and leases tend to be for a minimum of five years.
Annual rent reviews usually mean rents rise by at least inflation each year.
Another key difference from buy-to-let is that the fund manager will identify which properties to buy, and manage the properties and tenants, offering investors an investment with hands-on work required.
Commercial property has prospered in recent years, achieving double-digit returns in 2013, 2014 and 2015, with a rise in economic growth helping drive the boom.
However, recent events such as Brexit have highlighted some of the downsides of direct commercial property funds.
Disadvantages Of Investing In Commercial Property Funds
Funds normally have a cash buffer to cover withdrawal requests.
However this buffer won’t be enough if large numbers of investors want to make withdrawals at the same time, forcing the fund manager to sell properties to meet redemption requests.
Selling commercial properties in uncertain economic conditions – such as now – could mean the fund manager would not be able to realise their full value.
In order to protect other investors, funds have “lockout clauses” which let fund managers shut off payments to investors wanting to exit the funds under “exceptional circumstances.”
In the wake of the EU referendum result, some funds invoked these lockout clauses.
Advice about whether investors should redeem their money from a property fund in a property downturn is mixed.
Some experts argue that being locked into a commercial property fund may not be a terrible thing because property investing is long-term and investors should not look to jump in and out of funds investing in this relatively illiquid sector.
Making Complaints About Property Funds
According to the Financial Ombudsman, for a complaint to come under their remit, it must be about a “regulated activity” as defined in the Financial Conduct Authority (FCA) Handbook.
Generally, the Ombudsman does not look into complaints where consumers have invested directly into property themselves or have control over the underlying investments – because these activities are not regulated.
However, it can usually consider complaints about investments in regulated collective funds.
The Ombudsman first consider whether the complaint is viable before looking into the merits of the case.
A key consideration is if the consumer has control over the property held by the fund – if they do, it is unlikely they will able to consider it.
However, where a consumer has been advised to invest directly in property within a self-invested personal pension (SIPP), the Ombudsman may be able to look into the complaint against the adviser.
The Ombudsman can consider complaints about numerous issues. Here are a few examples:
- Suitability of property funds. Property sales can take a while to complete and it can be hard to establish an accurate valuation of individual properties. As a result, consumers face certain risks when investing in property funds, such as volatility from a particular market or sector or changes in exchange rates. The Ombudsman will take these into account when deciding whether or not a particular fund was suitable.
- Delays when withdrawing money. In some circumstances, a “deferral period” applies when consumers try to withdraw from a fund or switch their investment into another fund. This means that a business will not act always immediately on instructions, but will instead promise to do so as soon as possible within a set deferral period. When considering a complaint about a deferral period, the Ombudsman will look at whether the business was contractually entitled to apply it; the consumer was told it might be applied and the consumer’s position was damaged.
- If the Ombudsman finds the consumer told the business at the point of sale that they might need access to the capital they were investing at short notice or at a specific time, they are likely to say that the investment was unsuitable.
Correcting A Complaint
If the Ombudsman is satisfied that a particular fund was unsuitable for a consumer, there are several approaches to calculating compensation.
Firstly, they will look at the individual circumstances of each case and decide what they think the consumer would have done if they had not invested in the fund.
If a deferral period is in place, it could be difficult to calculate an accurate surrender value of the fund.
In some circumstances, the Ombudsman may ask the financial business to waive the deferral period. If this is not possible, to take ownership of the consumer’s investment and pay the consumer the amount that was originally invested with an appropriate rate of return.