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BALANCING THE WEALTH MANAGEMENT PORTFOLIO: THE BENEFITS OF INVESTING IN COMMERCIAL PROPERTY

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Ian Froome

Land and property has a place in many balanced investment portfolios. However many people’s knowledge of property is limited to the residential sector and their own housing – meaning that some investors will not consider commercial property as an option.

Ian Froome

Ian Froome

In this article, Ian Froome, partner at property consultancy Vail Williams, outlines some of the key characteristics of land and property as an investment vehicle, focusing principally on the commercial aspects.

As with any investment, there are positives and potential negatives when it comes to considering property.

Benefits

  • Property is a tangible and finite asset.  All investments carry an element of risk, but with property – no matter what happens – the owner will always have the land, and with that comes an opportunity to rebuild the investment value
  • Land and property is an easily understood asset class, at least at a superficial level. It is the nuances of tenure, leases and covenants that need expert care
  • Property is an investment with a very long shelf life. Some buildings suffer obsolescence, but that is usually also an opportunity to redevelop and create additional value. The underlying land does not ‘mature’ or terminate as with some other investments
  • Most commercial property investments are leased on a ‘full repairing and insuring’ basis, meaning the tenant is responsible for all costs relating to that property. This is a key difference from residential property, where the landlord remains responsible for buildings insurance and external repairs. Multi-let commercial properties (such as an office building with a different tenant on each floor) allow the landlord to recover shared building costs through a service charge. In most cases, the landlords can even include management costs within this service charge, meaning the rental income is generally a clear net income.

Drawbacks

There are also potential pitfalls to property investment that need to be considered alongside the benefits. In most cases these pitfalls can be avoided or even made into a virtue or opportunity.

  • Some classes of property investment are prone to ‘bubbles’ but this is true of most asset classes and the resultant crashes do have limits
  • The often-quoted example is residential; we are all waiting for the next house price crash. If the underlying characteristics of the investment are right, however, this risk can be mitigated, even if Woolworths were your tenant
  • If the unlucky property investor sees values falling, that fall is limited to the underlying value of the land – it won’t disappear into nothing like a 1990s dot.com share investment
  • Property can suffer a lack of liquidity, especially when funding sources are limited
  • For example the recent recession and credit squeeze reduced the number of buyers, so sale periods were longer than average
  • There can be significant holding costs for vacant commercial buildings. These include insurance and empty property rates which can be substantial. This means that the long-term security of the lease is a key factor when pricing a commercial property investment
  • Quality property investments can be hard to find. This can of course be a virtue for those lucky enough to hold good quality stock since the excess of demand over supply can help capital growth.

The nature of supply and demand

One of the key challenges for property investors is finding good quality stock. This has been exacerbated in recent years by the dearth of new development.  As the economy improves there will be more money seeking an investment home, boosted by initiatives such as the Bank of England and HM Treasury’s Funding for Lending scheme.

This potential growth in demand linked to static supply might well lead to a bubble where people pay over the odds for average investments just to secure something. Investors need to make sure that they don’t lose sight of the fundamental characteristics of any investment when buying property – don’t just follow the herd.

Pricing property investments

Any investment should be priced on two fundamentals: firstly the security of the income, and secondly the potential for income or capital growth. 

One of the main differences between residential and commercial investments is that most buy-to-let investors seek growth mainly through capital value appreciation. A commercial property investment should rely much more on the income growth potential. 

Some sectors provide a good secure income but limited growth, for example offices let to strong covenants on long leases. Others offer less security but better income growth prospects – an example would be an industrial unit on a sought-after estate but let on a short lease. A precious few offer both strong income growth potential and good security, an example being a modern and well located convenience store let on a long lease to one of the major supermarket chains.

Investment structures

There are many specialist ways to hold property, but popular niche opportunities include:

  • Hold in a SIPP (Self-Invested Personal Pension)
  • Particularly tax efficient for business owners with freehold property
  • Does not apply to residential property
  • Hold in an associated company
  • Impact on the balance sheet, may be positive on net asset value
  • May have tax implications if the value of the company increases
  • Note that a leasehold property where a ground rent is payable may be a liability on a balance sheet

Permitted development – from office use to residential

A major change to planning legislation this year is the introduction of permitted development rights allowing, in certain cases, a change of use from office to residential.

The potential to convert to residential use may provide a lifeline to the owners of older office buildings, or ones that are no longer in suitable commercial locations. However the rights are not unfettered and some planning controls still need to be faced, for example on the traffic impact, flood risk or any major changes to the structure of the building. If these are an issue then a planning application would still be needed. Nevertheless the legislation signals a clear intent to the principle of the use change which could help to de-risk some office investments.

Summary

Looking at the investment market from an international perspective, the UK is seen as a safe haven for investors. We have a stable political and legislative framework that encourages long-term investment options – attractive to investors from less secure environments.

Like all investments, the property market experiences peaks and troughs. It is vital therefore to take a long-term view and also to spread risk in a balanced portfolio – investing across different property types and / or locations. Such a healthy approach should ensure healthy returns.

For more information about Vail Williams LLP, please visit www.vailwilliams.com

Investing

Are clients truly getting value from their BR solution?

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Are clients truly getting value from their BR solution? 1

By Matt Dickens, Senior Business Development Director at Ingenious

Financial planners and wealth managers strive to deliver on the needs of their clients by always providing the most suitable and effective advice. But as with any service, this advice should also be delivered at the best possible value for the investor. Value can be simplistically defined as the service that delivers the most benefit, balanced against the financial cost, but in the estate planning space, how do you assess what good value is?

1. Total fees and charges

Product fees are guaranteed to negatively impact returns, so it is important to minimise their impact when looking to gain the best value from the investment. Some managers report little or no fees paid by the investor to the manager, but instead charge the company or investment service itself. While this might initially be seen as better value for the investor, it is not as simple as that. Investors in unlisted BR services become a shareholder of the portfolio companies, so the reality is that any fees paid by the companies are effectively being paid by the shareholder (or investor). Therefore, both investor fees and company fees will both negatively impact the final return and must be considered together.

Analysis of what a manager is paid by the investor and by the company over a significant period will enable an adviser to conclude if the manager is offering good value, or if a disproportionate amount of fees is going to the manager at the expense of their investors.

2. Real investment returns

Another key component of assessing value is what the investment actually delivers. For BR solutions, investors’ main objective is commonly to pass on the maximum sum possible to their beneficiaries upon death. This may lead to a conclusion that delivering Inheritance Tax relief at the lowest possible cost is the primary driver of value. However, especially for clients with longer time horizons, the one-dimensional goal of avoiding a potential 40% Inheritance Tax bill can easily over-shadow the equally important goal of aiming to steadily grow the investment, preventing erosion by inflation, drawdowns and investment fees. Unlike some IHT-focused solutions, such as trusts or gifting, investors in BR services do not have to accept zero growth of their wealth from the point of investment.  Instead, investors can continue to earn returns, either taking an income stream or increasing the final sum to be passed onto their beneficiaries, precisely in line with their original objective.

While most BR managers predict their ongoing returns at a certain level, those targets are not guaranteed and historic performance varies widely.

3. The relationship between fees and risk

Given that the majority of managers in the BR space state their performance targets net of fees, to produce positive growth and achieve their target return, those managers must first earn back any fees they are taking. Let’s take the below scenario to illustrate this point.

 Are clients truly getting value from their BR solution? 2Manager 1

Annual performance target, net of fees: 3%

Annual fees: 3%

Gross performance target: 6%

 

Are clients truly getting value from their BR solution? 3Manager 2

Annual performance target, net of fees: 4%

Annual fees: 1%

Gross performance target: 5%

Initially, it might appear that Manager 2 must be taking more risk to target a higher net return of 4% than Manager 1, who is targeting 3%. However, Manager 1 has to deliver an additional 2% of gross return than Manager 2, to make up for charging higher fees. Higher fees not only impact returns and value, but they can also mean greater risk.

Market comparison

In the Tax Efficient Review’s most recent analysis of Unlisted BR Services1, they released data that ranks services in the market in terms of both investor returns and total fees. IEP Private Real Estate achieved the top rank for returns delivered, with the second lowest total fees in the market, demonstrating that it represents attractive value for investors in comparison to other services.

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Reuters Events Launch Global Investment Summit Online Edition Uniting Institutional Investors, Asset Owners & Financial Institutions

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Reuters Events – today announced the agenda for their Global Investment Summit (Dec 3rd -4th). The 2-day strategic summit has been reimagined in the era of social distancing and will be broadcast free of charge to the public.

This Summit, with a diverse range of international voices and anchored by Reuters News-led sessions, is the only place for institutional investors, asset owners and financial institutions to come to terms with the events of 2020.

Click for more information and for complimentary registration to the online edition

The Energy Transition team report an industry leading speaker faculty for 2020, including:

  • Eileen Murray, Chair, Finra
  • Philip Lane, Chief Economist, European Central Bank
  • Gregory Davis, Chief Investment Officer, Vanguard
  • Hanneke Smits, CEO, BNY Mellon Investment Management
  • Pascal Blanque, Chief Investment Officer, Amundi
  • Desiree Fixler, Group Chief Sustainability Officer, DWS
  • Joe Lubin, CEO, Consensys
  • Bahren Shaari, CEO, Bank of Singapore
  • Mark Machin, CEO, Canada Pension Plan Investment Board

The agenda released by Reuters Events Investment is both ambitious and comprehensive, and will cover four key themes: Market Outlook, Asset Management Strategies, Industry Deep-Dives and the Future of Investment.

View the full agenda here

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Halliburton & Baker Hughes CEO’s join Reuters Events: Energy Transition 2020

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Reuters Events – today announced that CEO’s of two of the world’s leading energy service companies, Halliburton and Baker Hughes, will join the speaker faculties for their flagship Energy Transition Summit.

The event will explore the creation of the future energy ecosystem and offer companies, from across the asset spectrum, a definitive guide to their net-zero strategies. The alignment of the two biggest O&G global service companies, Halliburton and Baker Hughes, represents a significant step in the transition to low-carbon energy

More information on the Europe and North America editions can be found below. Registration for the LIVE stream is free.

Alongside their CEO speaker representation, Halliburton join as Platinum sponsors of the North American edition. Baker Hughes join as gold sponsors for the European edition of the flagship energy transition program.

The Energy Transition team report an industry leading speaker faculty for 2020, including:

  • Lorenzo Simonelli, Chairman & CEO, Baker Hughes
  • Jeff Miller, CEO & President, Jeff Miller
  • Tristan Grimbert, CEO, EDF Renewables
  • John Pettigrew, Chief Executive, National Grid
  • Pratima Rangarajan, CEO, OGCI Climate Investments
  • Alex Schneiter, CEO & President, Lundin Energy
  • Gretchen Watkins, President, Shell Oil Company
  • Calvin Butler Jr., CEO, Exelon Utilities
  • Francis Fannon, Assistant Secretary ERB, S. Department of State
  • David Lawler, Chairman & President, bp America
  • Andreas Schierenbeck, CEO, Uniper

More information on the Europe and North America editions can be found below. Registration for the LIVE stream is free.

Governance & Cooperation – Does the energy transition face a ‘governance deficit’? To understand how the energy transition will develop over the next decade, it is crucial to understand the driving governing forces behind it. Will the Green Deal provide the first domino, how can we ensure progress in the shadow of Aberdeen and ensure that we translate targets into action?

Financing Energy Transition – We must address the elephant in the room; who is going to pay for it all? An understanding of where the funds are likely to come from is key to staking claim to the infrastructural projects that will redefine the modern world in the 21st century.

New Energy Infrastructure – Low-carbon energy supply and consumption will need a radical overhaul of infrastructure. As well as revamping the old, we’ll need entirely new assets and new systems of energy delivery. It’s an unprecedented opportunity with estimated spending at $70 trillion over the next decade. Knowing which technologies are ready to be scaled first is the key to understanding opportunity

Business Model Innovation – Who will provide leadership through the age of transition and how do we want our future energy system to look? Speed and timing will be crucial if you are to stay on the right side of the transition. Join us in setting business led, evidence based, targets as industry drives towards net-zero

More information on the Europe and North America editions can be found below. Registration for the LIVE stream is free.

At Reuters Events, we’re committed to tackling the Energy Transition head on; to shed light on the defining issue of our time and help energy companies meet a uniquely difficult challenge. That is, to be both an energy company of today, and the energy companies of tomorrow. In a period that will be defined by uncertainty we can, together, lighten the way forward.” – Owen Rolt, Head of Energy Transition, Reuters Events

Contact

Owen Rolt

Head of Energy Transition

Reuters Events

UK: +44 (0) 207 375 7596

E: [email protected]

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