Property funds have been popular with both investors and financial advisers for many years.

Property is traditionally one of the four asset main classes within a diversified or asset allocated portfolio designed to minimise risk and reduce volatility. The other three asset classes are cash, equities (shares) and bonds (government and corporate bonds).

By property, I mean commercial property which is divided into three sub-sectors of retail, office and industrial property. Whilst there are some specialist residential property funds these are relatively rare.

Commercial property, bonds and cash (bank deposits, term deposits and their equivalent) have traditionally been considered low-risk assets. Depending on the constituents of the fund some commercial property funds may be considered medium risk rather than low risk.

By commercial property funds, I am specifically referring to OEICS in the main and the occasional unit trust. Most investors, especially those who have a financial adviser, tend to invest in property OEIC funds these days.

Personally, I have had an issue with property OEICS for some time. Why is this?

Well, the problem is that the way an OEIC (Open Ended Investment Company) is structured means that when an investor invests or sells the OEIC has to create new units or sell existing units together with the assets in the fund. So if there is a large demand to sell units in an equity fund OEIC then the underlying shares are sold quite quickly and the units cancelled. The problem with property fund OEICS is that the underlying asset, property, cannot be sold instantly so if there is too much selling demand there will be insufficient cash to repay to the investor. When this happens the fund is forced to suspend trading which means that the investor cannot sell his units. This is due to a lack of liquidity.

I only recall this happening three times in recent history. The first time was during the banking crisis of 2008, the second time was after the Brexit vote in 2016 and the third time was during the Coronavirus pandemic in 2020. On all occasions, investors panicked and tried to sell their OEIC property funds. On all occasions, such funds were suspended for many months so investors had to wait to encash their funds.

I have a problem with this because OEIC property funds are considered to be low to medium risk investments yet at times they have very poor liquidity meaning investors cannot access their money. In my mind that makes such funds high risk. The inability to access your money when you need it is a high-risk outcome.

Furthermore, in order to meet the demand for withdrawals, such funds tend to keep large amounts of money in cash and not fully invested into property. This means that optimal income in the form of rents and capital gains cannot be achieved.

So all in all a poor outcome for investors in my opinion. So what is the answer?

Well, I favour Real Estate Investment Trusts or REITS. Why?

An investment trust is different to an OEIC because it is a closed-ended investment as opposed to an open-ended one. This is a crucial difference. Because an investment trust is a share, investors can buy and sell shares without the underlying investments being sold. This means that when an investor wants to sell shares in a REIT, in other words, a property investment trust, he can do so freely without the underlying property being sold. This means that REITS do not become suspended when there are a lot of sellers so the lack of liquidity isn’t an issue.

Does this make REITS less risky than Property OEICS? Well in theory no. That’s because REITS, being shares, perform like equities. In other words, they can be as volatile as other equities. However, does greater volatility mean higher risk? Well no. Higher volatility simply means higher volatility. Period.

Investment Trusts do not have the protection of the Financial Services Compensation Scheme whereas OEICS do but so what? No OEIC in the 60-year history of the scheme has ever failed and lost an investor money. So a claim under the scheme for an OEIC failure has never materialised. So how valuable is the protection? In practice only for peace of mind.

Investment trusts such as REITs do have a particular pricing anomaly. At times the share price may be at a discount to net assets or at a premium. What does this mean?

It means that at times the entire net asset value, NAV, of the company can be valued at less than the current share price multiplied by the number of shares. That’s a premium to NAV. Equally where the opposite applies, that’s a discount to net assets.

A discount to net assets means you are effectively buying the assets of the company primarily represented by the properties at a discount and that discount can be very wide at times. Will that discount narrow or widen? It could go either way but there is a good chance it will narrow in which case you get an extra capital gain for nothing! Lovely Jubbly as Del Boy of Only Fools and Horses would say.

The other main benefit of REITS is that they do not have to horde large sums of cash to repay sellers meaning they can invest more money into commercial property and potentially receive higher income and make larger capital gains.

Overall REITS are seriously worth considering if you wish to invest in property funds in order to create some diversification of risk in your investment portfolio and to avoid some of the pitfalls of property OEICS but do remember that such investments are more volatile.

Do your research carefully before investing or seek the advice of an Independent Financial Adviser. You know it makes sense.*

*The contents of this blog are for information purposes only and do not constitute individual advice. You should always seek professional advice from a specialist. All information is based on our current understanding of taxation, legislation and regulations in the current tax year. Any levels and bases of relief from taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future. This blog is based on my own observations and opinions.