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The Actuary The magazine of the Institute & Faculty of Actuaries
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Property investment funds

The introduction of property investment funds (PIFs) could have a substantial and favourable impact on the real estate sector. However, the impact is entirely dependent on the PIF model and the specific details ultimately proposed by the government. An overly prescriptive structure will run the same risk of failure that greeted housing investment trusts (HITs).

REIT across the pond
International experience has also shown that the development of the real estate investment trust (REIT) market can be slow and is critically dependent on a favourable structure. The US experience, where REITs have been in existence since 1960, shows that there was only notable growth in the market size following tax reforms in 1986 and modernisation in 1999, which together provided a more suitable structure for conversion and the operation of these funds.
Successful collective investment vehicle structures have become dominant players in the US and Australian markets. The US REIT market’s current capitalisation is approximately US$375bn in 180 funds, representing around 14% of the market. In Australia there are 53 listed property funds, accounting for 49% of the total assets of all Australian property funds. Assuming similar take-up in the UK and applied only to commercial real estate where the institutional market is circa £250bn, the PIF market could control between £35bn and £83bn.

Enhanced choice
PIFs would probably appeal as an investment to a broad range of investor groups. They would certainly enhance the choice of investment for the small retail investors who currently have few tax-efficient investment options. Pension funds (both large and small) already have a variety of tax-neutral vehicles available to them and PIFs will only add to this range, but they will also provide another tool for adjusting portfolio strategy. A critical test for institutional investors will be whether the performance of PIFs correlates more closely with direct property or the equity market. The fundamental case for property investment is often based on its low volatility, counter-cyclical merits, and portfolio diversification benefits. This balance may be altered if not lost in a listed vehicle, which would be more liquid but potentially more volatile. It is the greater liquidity that may, in turn, create the higher volatility as investors choose to enter and exit cyclical areas of the market via the PIF investment route.
An unlisted vehicle is likely to be less volatile and therefore of more interest to institutional investors. We would anticipate a higher level of institutional demand assuming a favourable tax regime and specialist sector orientation. Much of their success will depend on the level of income distribution. In keeping with the successful international practice, income distribution should be 80% to 90% after depreciation.

Discipline and transparency
The concern over increased volatility may be misplaced. In the US, REITs are thought to have brought more discipline to property investment, helping to even out market cycles and increase market scrutiny. A similar structure for UK PIFs will hopefully help to increase market transparency and information availability. There is potential for PIFs to have a destabilising effect in the short term as new money enters the sector, but over the longer term (with increased market specialism and expertise) PIFs could have a smoothing effect. An imbalance will, however, remain if the flow of investment funds dictates the level of occupational supply.
The UK currently has the most mature and sophisticated property investment market in Europe. If PIFs are structured to allow investment in non-UK markets, there is potential for the UK to become the centre for the European property fund management industry with positive implications for tax revenue and employment. However, for this expansion to happen, the property tax regime needs to accommodate funds being set up in the UK and stem the flow of property assets being domiciled in the Channel Islands via property trusts and limited partnerships.
PIFs could have an important and positive impact on the real estate sector, but they need to be structured correctly to attract the investors, and this may not be achieved at the first attempt. o

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