SHOULD PROPERTY STILL FORM PART OF A BALANCED INVESTMENT PORTFOLIO AND IF SO, HOW?
The current stock market turmoil, crisis in the housing market and slump in demand for commercial property all point to a safety first attitude to investment. IFAs understandably are reluctant to recommend anything to clients at the moment however small the risk. Yet now is, of course, the moment when the expertise and knowledge of the IFA should be exhibited to the full, after all any fool can make money in a bull run it is said.
There is a wall of money building up that will soon have to find a home whether investors are seeking income or capital growth. We will shortly be in the bonus season (and yes, there will be bonuses), inheritances are falling in and pensions vested, so what is the sensible, experienced IFA to do when clients come seeking investment advice? It is important to get back to basics.
Is the investor looking for a short term fix, in which case cash will always be king or is he, as perhaps he should be, looking to balance risk and reward for a relatively safe medium-to-long term investment? If so property in some form or other ought to be part of any properly balanced portfolio of investments not least of all because of its contrarian nature.
It is generally agreed that the minimum amount of time property should be held for is five years. Historically, as IPD surveys show, property is consistently a top performer over the medium to longer term. A recent Rathbones' risk/reward comparison survey of 10 asset classes showed property gave the second highest return over 15 years to Private Equity and yet just the fourth lowest volatility behind cash, gilts and fund of hedge funds.
So, if we accept that commercial property in particular should continue to fulfil its historic role of being part of a balanced portfolio where to now? It is difficult to persuade investors, with the morass of office building taking place in the UK, that there is not overcapacity just as the economy is going into recession and that it is safe to go back into that market.
This is where an informed IFA should be demonstrating his worth by showing his clients that he is thinking differently and doing his research, not relying on redundant property models.
There are other types of commercial property, relatively new to the UK yet to be fully embraced by the IFA community, although very successful in America for a number of years. The concept of fractional ownership, quite common with private aircraft and boats is being applied to commercial property. We have seen a similar form of this type of investment with syndicated property SIPP investments but now it is beginning to take off in Europe and elsewhere with fractional ownership of hotels.
The basic principle is that investors own a fraction of a hotel entitling them to a share of the income generated by guests staying in their ‘allocated' room together with a capital gain related to growth in the hotel's freehold value proportionate to their fraction.
The overcapacity so evident in the empty office blocks is the result not only of recessionary forces but also virtualisation. As more and more office workers are hooked up to the internet at home there is less need for the cost in both time and money of transporting millions to purpose built office premises. There is however no substitute for the real bricks and mortar of a hotel. Irrespective of working patterns there will always be a need for hotel rooms where itinerant executives can abide for face-to-face meeting as well as, of course, for them and the rest of us to go at leisure time.
The IFA needs to choose carefully and consider a range of factors as he would with any other investment recommendation. Again, a back to basics approach will serve the IFA well. Standard considerations need be made. Income will only be achieved by guests staying at the hotel so if the client is seeking regular and/or increasing income then does the hotel have high occupancy levels, is the hotel seasonal and how much of the room's rental value is retained by the operator. How experienced is the hotel's management team and how adept are they at achieving or maintaining high occupancy? The IFA must also consider the capital position; does the property have good potential for capital growth?
Hotels, as a business structure, have a number of specific running costs inherent in their nature, the IFA must ensure that all future costs and liabilities are identified and allocated. Before recommendation the IFA will have to know where his clients' liabilities lie for management costs, legal and survey fees or any ongoing service charges.
In the current financial climate he should also ask about levels of indebtedness, is it a going concern or are there any refurbishment costs and/or delays anticipated and what impact on occupancy and profitability will they have? Many offerings offer a guarantee but some are based upon future room occupancy levels so what effect would lower than advertised levels of occupancy have on the guarantee?
One of the pioneers of fractional ownership of hotels in the UK was GuestInvest. Their business model was London centric where property prices may have already peaked, carried crippling development costs and had investments starting from £250,000 all of which made them vulnerable to the credit squeeze. As if that was not enough, they were partnered by Bank of Scotland! There are however a number of other organisations who put together attractive propositions for an alert IFA to research with considerably more attractive business models.
Most offer, as an investment perk, a number of nights free accommodation annually with the investment. The locations of these offers range from Hull to Hawaii so the IFA needs to ensure that he is aware of his clients' personal leanings which add a further dimension to his KYC responsibilities. Unless the investment is to form part of his clients pension funds, the attractiveness or otherwise of the investment perk will have to be factored in with the cash cost of the investment.
It may appear daunting, and certainly this type of recommendation raises a very different set of questions, but the fundamental responsibility of the IFA is no different to his recommendation of any other investment – it is his duty to demonstrate that he has effected due diligence and having done so he will then be able to demonstrate to his client that he is prepared to go that little bit further for him, to look beyond the more traditional route into the investment property market and that he can offer reliable and seasoned advice for a new, sexy alternative that might just tickle the jaded palette of his most recession wearied client.
Chris Rathbone
IFA Sales Manager
Room to Invest (Cyprus) Limited