Include property as part of a well balanced investment strategy for retirement

Property is considered to be one of the largest and most widely held asset classes. It presents itself as a secure and balanced investment and thus satisfies the moderate risk appetite. Its tangible nature and attractive risk profile makes property an asset class that trustees would naturally wish to include in any retirement fund.

 

However, it requires careful consideration and ground-work. What you choose to invest in is crucial in determining the rewards. The key is to understand what to invest in and the decisions impacting that investment. Trustees looking to invest members’ retirement fund in property could consider four options.

In boom times, property syndications have rewarded investors with high returns. However, the failure of many high profile property syndications has confirmed that the expected return does not always compensate for the risk. Failures occurred primarily because investors were invested in unsecured debentures, with only a small amount of that investment secured by property. Due to their structure, property syndication is not recommended as a vehicle for retirement fund monies.

Regulation 28 states that a fund may invest up to 15% of its assets in immovable property. To ensure diversification, it also states that no more than 5% may be invested in a single property. So while a fund now has the opportunity to buy physical property, there is difficulty in this approach – especially for small and medium sized pension funds.

 

The difficulty of the Regulation 28 requirement lies in the price range of property. As an example, an average sized fund has R20 million worth of assets. As illustrated in the diagram below, 15% of that R20 million may be invested in immovable property, which is a reasonable R3 million. But, of the initial R20 million only 5% may be invested in a single property. R20m X 5% = R1 million. In the current property market, what can be bought for R1m?

Diversification reduces risk. Adequately diversified property portfolios include a range of commercial, industrial and retail properties to protect investors from downturns in any of the sectors. Geographical diversification ensures that the risk associated with investing in property is spread over a combination of established and emerging regions.

 

If the retirement fund with assets of R20 million can only invest in three properties of R1 million each, how diversified can the the portfolio be in terms of sector or region?

How will the property be maintained? Owning a property is similar to owning a business. It needs to be run effectively in order to generate return. Management can be easily outsourced. The difficulty comes in selecting the right managing agent as it impacts the future value of your property as well as your tenant experience, turnover and demand.

 

Retirement funds can invest in property portfolios (and reap the benefits of the security provided by property ownership) without directly managing or owning a property.

A listed property fund, as illustrated in the graph below, is vulnerable to market sentiment. The volatility of shares has a direct effect on listed property. As a result, it is vulnerable to market sentiment and fails to offer the stability of direct property fundamentals.

Unfortunately, listed property does not follow property fundamentals, i.e. it does not show steady capital growth accompanied by ongoing rental income. Hence, trustees do not get the diversification from equities that they are looking for when investing in listed property.

 

An unlisted property portfolio on the other hand, offers diversification from the equities market, as its performance is not linked to market sentiment. An unlisted property portfolio offers significant returns based on the property fundamentals - rental income and capital appreciation. This means that as inflation escalates, so does the property rental price and the overall value of the property. Ultimately, an unlisted property portfolio offers pension fund trustees a property investment without having to worry about the pitfalls of having to buy a property.