Property is an important diversifier for charity funds

07 August 2019

In the past, most charities' investment portfolios have consisted mainly of equities and bonds, but in today's volatile economic environment it has never been more important for charities to hold a diversified portfolio of investments. One of the best performing asset classes over the past three, five and ten years has been commercial real estate (retail, office, industrial and alternatives - uses such as hotels, student accommodation, self storage), which can help add an extra element of diversification and stability to investment portfolios for several reasons:


Firstly commercial property delivers a high (and relative to bonds - very high) level of income. This income also tends to be relatively predictable - even in times of economic uncertainty when companies may issue profit warnings, announce redundancies and suspend dividend payments, tenants still continue to pay their rent, as they have no choice if they wish to continue trading.


Secondly, commercial property has historically been a less volatile investment than equities or bonds, partly because of this high and stable income component (circa 5% per annum on average over the last 5 years). We don’t see this significant advantage being eroded any time soon, with base rates and gilt rates remaining low for the foreseeable future.

Fig 1 - Property yields continue to offer a significant yield advantage

Source – MSCI 2019

Unlike other investment classes, property represents a tangible, real asset. Therefore, instead of simply being restricted to buying and selling, investors can improve returns through active management of their investments. This can include, for example, refurbishment and extension of a property or a change of planning use class to facilitate a higher value use. It might also include taking a surrender of a unit in a multi-let property in order to secure a new letting at a higher rent thus creating rent review evidence for the other units.


Turning to current market conditions, the commercial real estate market delivered remarkably stable returns last year of close to 7%. However the devil is in the detail and there are areas of both strength and weakness. Shopping centres and the majority of high streets are in decline, with a number of high profile occupiers entering administration (Debenhams, LK Bennett, Maplin, Toys ‘r’ Us) or using the CVA mechanism to shed stores and reduce rents (i.e. Carpetright, Mothercare, Arcadia and Homebase). This sub sector is best avoided for now. However, still in the retail sector, the supermarket operators have been doing well, with Aldi and Lidl continuing to expand and Tesco having bounced back strongly. Elsewhere the outlook is much more positive – logistics has been performing particularly well due to the growth in online retailing. In the alternatives sector, the budget hotel and self storage groups have been on a roll and are expanding quickly; London has performed very well since the referendum vote (contrary to many people’s expectations) with record occupational take up and record overseas investment. All these sectors are being helped by a lack of new supply as the prevailing cautious atmosphere in light of the continuing Brexit negotiations hold back speculative development.


So how should one invest in this sector?

  •  Investing directly 

Just like buying your own house, investing directly has the benefit of owning the property outright and being in complete control. However, remember that direct property can be illiquid due to the long sales and marketing process compared with shares and bonds, plus you will also need to manage the building yourself and decide when is the best time to sell – one of the most difficult things to judge with any investment.

 You would also need to decide whether you will be able to maximise performance by exploiting all the potential angles: refurbishment, redevelopment or change of use, and would you be prepared to suffer the fall in income whilst you do this or if a tenant became insolvent?  

 This may depend on your charity’s constitution — if you are a total return fund this may not matter, but if you are permanently endowed it may be more problematic. Generally owning directly tends to appeal to larger charities because they have the scale to be able to afford a large diversified portfolio of buildings let to multiple occupiers. This means they are insulated in the event of, say a tenant default on an individual property. 

  • Investing indirectly through a REIT 

Real Estate Investment Trust (REITs) are an easy way for individuals to invest in commercial properties without the need to buy any one building outright or to take on the associated hassle of dealing with tenants. Whilst REITs are well established as a form of investment worldwide, they were only launched in the UK on 1 January 2007. If you choose to buy shares in a REIT you will not be buying into an individual property but instead putting your money into a fund which buys properties for letting purposes. This eliminates the risks associated with ‘having all your eggs in one basket’ as the fund will own various properties, potentially over various sectors of the property market. So, effectively, you will own lots of tiny slices of many properties (which is almost identical to investing in a Common Investment Fund (CIF) like the Charities Property Fund). Nine UK property groups elected to convert to REITs at the outset on 1 January 2007, and they include the likes of British Land and Land Securities and others have been launched subsequently. Some also specialise in a particular sector (such as INTU – shopping centres and Supermarket REIT). As part of their requirements to be granted REIT status, a property owning company must distribute 90 per cent of their rental income directly to its shareholders in the form of a dividend. In return the REIT becomes exempt from paying any Capital Gains Tax.

There is a tax downside, however, in that REIT’s do have to pay SDLT (currently levied at approximately 5% on any commercial transaction) and dividends will be subject to withholding tax. Neither of these apply in a CIF. 

  • Investing indirectly through a Common Investment Fund / Unit Trust

Commonly known as Pooled funds (as they are set up with the aim of “pooling” together multiple investors), the rationale being to gain economies of scale and increased purchasing power. They allow access to a much larger and diversified pool of assets than you would be able to afford individually and access to professional management. Property is a capital intensive asset requiring critical mass to maximise returns and minimise risk - we estimate that the minimum size of property portfolio to achieve these objectives is some £50 million. Hence, for the majority of charities, which are unable to run their own segregated portfolios of such size, investment through pooled vehicles is perceived to offer many advantages, such as:

 Property diversification – First and foremost, by pooling their interests the charities can access much larger portfolios which provide the required diversification by type and geographical spread;

 Asset diversification – By holding units rather than large, “lumpy” individual buildings charities can manage their overall exposure to real estate and adjust their portfolio weightings more easily;

 Lot size – Larger pooled portfolios can acquire larger buildings than individual charities acting on their own account. This may also allow access to markets previously out of reach (Central London for example).

 Management Time – Property investment is a management intensive, specialist field. Investment through pooled schemes reduces this onerous burden for Trustees while enabling access to specialist property investment managers;

 Stamp duty land tax (SDLT) – Whilst levied on a sliding scale most properties incur SDLT of close to 5%. Charities are exempt. By acting collectively, in a special charity vehicle, this gives a clear performance advantage.

 ESG - Being seen as a ‘responsible investor’ is becoming increasingly important to Charities and a charity specific Common Investment Fund will actively promote environmental, social and governance (ESG) aspects in its investment philosophy. They will also have an ethical policy. The Fund Management team will work together with a third-party sustainability consultant to follow an ESG Roadmap, specifying targets and objectives to enhance ESG performance throughout the portfolio. These funds can also apply a Negative Screened Investment Approach, avoiding investment in properties whose tenants could potentially cause embarrassment to unitholders e.g. arms and tobacco.

 Those few charities of sufficient overall size able to run their own property portfolios can achieve for themselves all the benefits outlined above. For the majority of schemes, however, it is only through a pooled approach that they will achieve the similar rewards of investing in property.

The best known example of this approach is the Charities Property Fund (CPF).

CPF was the first fund set up specifically for charities and is a Common Investment Fund. The Fund itself is a registered charity and is tax exempt, the main benefit being exemption from paying stamp duty (which is normally levied at 5 per cent on most commercial transactions), but there is no withholding tax payable either. The Fund is the largest charity specific fund owning £1.3 billion of commercial real estate, and is focused on the sectors which we believe have the best chance of outperforming the market.

In addition, CPF benefits from having an excellent regional diversification with 124 individual assets located across the UK and over 200 tenants (meaning no individual tenant failure would adversely affect the dividend). The Fund also benefits from having 33.3% of its income secured on leases with fixed or index linked rental increases, meaning investors are guaranteed some growth in income in the future. The average unexpired lease term remaining is 11.9 years and the quality of tenants is very good with 83.8% of occupiers considered to have a low or negligible risk of failure (compared to market average of 78.1%).

The Fund is currently yielding 4.2% per annum (net of all fees and costs). In 2018 CPF outperformed by a relative margin of over 10% and the margin of outperformance continues to be strong over 3, 5 and 10 years. (31.03.2019)

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