The Cavendish investment committee is responsible for reviewing our central portfolios to ensure that they continue to be best positioned to deliver on long-term investment goals. As part of that responsibility, the committee keeps under review a number of asset classes whose characteristics it believes could add value over the long term. This covers both the growth and defensive elements of the portfolios. The bar for inclusion of a new asset class is high as there needs to be a clear case from a theoretical and evidence-based perspective over many years. Investment providers must then also demonstrably meet our standards for robust investment structure, liquidity and risk management in the real world – all at a reasonable cost to the end investor.
One asset class that has remained on the committee’s ‘watch list’ over several market cycles is global commercial property. We will soon be slightly altering the composition of the growth allocation of our central portfolios to include some exposure to this new asset class via a ‘Global Real Estate Investment Trust (REIT) index fund.’ The purpose of this article is to explain what this new asset class is comprised of and how we intend to capture its returns through this very specific type of investment vehicle.
Where you use one of our central portfolios, you will in due course receive a recommendation from your adviser to bring your current investments into line with this thinking.
What would global commercial real estate bring to your portfolio?
Commercial property tends to have a different return experience to equities (even though individual REITs are listed on stock exchanges around the world). At specific times, and indeed across time, this can provide additional diversification to a portfolio.
Furthermore, as we explained in our recent article, “The return of inflation”, commercial property has provided long-term protection from inflation. In part, this is because many underlying rental agreements are linked to some measure of annual price increases. The world is currently experiencing a period of rising inflation as the economic recovery from Covid matures, but it is impossible to determine whether this will prove to be a transitory period of rising prices or something more sustained. Our investment philosophy explicitly acknowledges that nobody can predict the future and market prices constantly adjust to reflect information and the expectations of market participants. In this sense, we are not making a tactical decision or forecast about the outlook for inflation or any other economic variable. Instead, this is a prudent adjustment to portfolios that evidence suggests will be sensible for the long term, whatever may happen in the interim.
That is primarily because listed global commercial property brings something different to our portfolios in terms of broadening our diversification through the introduction of a different risk and return profile. In this context, a modest allocation to global commercial property makes sense for long-term investors, as part of their diversified growth assets.
How does COVID affect commercial property as an asset class?
During lockdowns, businesses around the world were forced to rethink the relationship between their workforce and their workplace. Even as we hopefully move from ‘pandemic to endemic,’ it is likely that the nature of office-based employment will have been permanently altered. We have become accustomed to working remotely, meeting friends and colleagues on Zoom or Teams and shopping more online. Global commercial property is a highly diversified asset class, but it is clear that all types of real estate will have been impacted to an extent as the pandemic has changed how we live our lives.
It is worth remembering, however, that this is an asset class that is used to constant change. The structure of the modern commercial property market looks very different to what it was fifty years ago. And it will look very different in the future. Some sectors will struggle, but others will prosper. For example, it is likely that traditional retail, which was already under pressure from the growth of online shopping, will have an even tougher time in the years ahead. However, even the online retailers need a physical presence for things like logistics centres and warehousing. Meanwhile, in the digital age, there is increasing demand in areas such as secure state-of-the-art data centres, and the climate crisis is driving change – and investment – in many other parts of the real estate market.
Admittedly, the outlook for the office sector is particularly hard to predict but, as is always the case with financial markets, that uncertainty and risk will already be reflected in the price of real estate assets. The future prospects for all types of commercial property will depend on what happens relative to the expectations that are already priced in. Those outcomes may be better or worse than expectations and we have no way of knowing what the future holds. What we do know is that commercial property will continue to be needed and that tenants will have to pay rent. Hence, we believe that a highly diversified approach to this asset class has a role to play in your portfolio.
What is a REIT?
As noted above, REIT stands for Real Estate Investment Trust. Historically, the primary way of gaining investment exposure to commercial property was to physically own the bricks and mortar assets. Clearly, this was only really an option for institutional or extremely wealthy investors. REITs, however, were introduced in the US in the 1960s, and then in the UK in 2007, as a structure within which investors can pool their assets to achieve a collective exposure to a diversified portfolio of property assets.
Since their introduction, REITs have become a well-established method of investing in commercial property. REITs are listed property companies that are almost exclusively focused on generating rental income and distributing it to their shareholders. As such, they represent a well-diversified and liquid way of providing exposure to commercial real estate.
Some REITs offer broad exposure across a range of different regions and property types, whereas others provide targeted exposure to a particular niche of the commercial real estate market. For example, the world’s largest REIT invests in more than 4,500 individual properties across 19 different countries and has more than $100bn in assets under management.
Within the UK, the largest REIT is an owner, manager and developer of modern warehouses and light industrial property. Its properties are located in and around major cities and at key transportation hubs in the UK and in seven other European countries. There are many other well-known larger UK REITs, but also many smaller REITs which offer targeted exposure to particular property niches like student accommodation, healthcare properties and social housing.
What is a REIT index fund?
Whilst individual REITs can provide a liquid and well diversified exposure to commercial property, REIT index funds take that liquidity and diversification to the next level. REIT index funds invest in a collection of REITs rather than directly into property, or into a single REIT manager, in order to track the general overall performance of the REIT market. As such, the level of diversification that is provided is significantly greater – and with it, the degree of stock specific, sectoral and regional risk is reduced.
For example, in a globally diversified REIT index fund, there may be more than 350 individual REITs. It is estimated that such a fund contains around 90,000 properties spread across property types, global markets and strategies.
We hope this note has helped to build your understanding of this type of investment and how it works. Your adviser will discuss this issue with you at your next annual review meeting, but in the meantime please do not hesitate to contact them for further information.