For investors lacking the millions needed to create their own healthy portfolio of properties, unlisted property funds can be a good way to get exposure to direct real estate. But many of these funds are specialist and a certain degree of expertise is necessary even when it comes to choosing the general vehicles.

Providers say they are stepping into the gap with multi-manager products based on unlisted property funds. Funds of funds are, they say, the best way of investing in a broad spread of direct property and getting property experts on your side.

Institutional investors looking for multi-managed unlisted real estate products have two routes to choose from.

The first route is to go to a big multi-manager provider such as ING or Schroders which offers an aggregated product run as a tailored account. The second option is one of the pooled multi-manager funds of funds investing in unlisted property funds. Aberdeen Property Investors is one such provider.

"It is a growing market," says Jose Luis Pellicer, head of research and strategy at Rockspring Investment Managers in London.

"Several different products have recently been launched, and this expansion is likely to continue until supply starts to exceed demand."

He explained that funds of funds are particularly suited to smaller pension funds that do not have the resources to do their own due diligence on several unlisted property funds, "It is a way of outsourcing this function," he says.

ING Real Estate Investment Management offers a multi-management service which gives investors access to a range of real estate funds and managers.

Nick Cooper, head of the multi-manager division at ING Real Estate, says clients looking for multi-managed property fund investments can either opt for a dedicated account which is tailored to their needs, or they can buy into a fund of funds product.

In order to have a dedicated account, a fund would generally need at least UK£50m (€74m) to invest, but the minimum investment in ING Real Estate's fund of property funds Osiris is UK£100,000 (€148,551).

Osiris is the biggest fund of its type in the UK and now has UK£400m under management. ING Real Estate says it was specifically designed for smaller pension funds which might otherwise have trouble getting diversified exposure. It invests in 23 different property vehicles, which in turn include more than 1,000 individual properties and 5,500 tenancies.

"We invest in a whole range of funds from balanced funds to opportunistic," says Cooper.

The fund of funds approach is particularly appropriate when it comes to unlisted funds. "If you take the smaller investor: because the funds are unlisted, you need a degree of expertise to detect which one to pick," he says.

"We are also seeing the growth of the fund of funds market in continental Europe.

"There are now a number of houses, including ING, offering these funds. The unlisted market in continental Europe is greater than that in the UK, so there are many opportunities. However, it is also quite opaque. It will change, but it's not there yet."

But for all the advantages that multi-management can offer, it does inevitably mean an extra layer of fees. Osiris, for example, charges fund of fund manager fees of 20 basis points. The fees of the underlying funds vary; the more opportunistic funds can charge high fees, but the idea, of course, is that performance will compensate for this. "Investors don't mind fees as long as they are not lopsided," says Cooper. Historically, real estate has not been correlated with other assets. While direct property investment offers investors a lot of control, they need to have the resources and the knowledge to make the most of that control and extract value.

However, not all pension funds have the resources for that, says Pellicer.

"For a pension fund to invest a significant amount of money annually into non-listed property funds, it needs to have the resources to be able to understand the vehicles it is buying into. And the industry is becoming more complicated. "I think it's a matter of resources and effort/reward ratio. If you want to make a big effort and keep a dedicated property team in house, then you will probably get your rewards and save the cost of a fund of funds manager."

SEI, which offers a wide range of outsourced asset management, has been working on a fund of funds vehicle for UK investors who want to invest in unlisted real estate funds.

Mark McCarron, senior client portfolio manager at SEI, began looking into this a year ago, and saw that there were two ways UK investors could gain exposure to property - either through buying the listed shares of property companies such as Land Securities and British Land, or by buying directly into property itself.

However, investing in listed shares, he says, would not really provide the underlying property characteristics such as lower volatility, a more stable income stream and lower correlation with other asset classes.

"That's why I wanted to give clients exposure to direct property - because although property shares might have a different underlying business - they behave more like equities."

The other option for clients was to go into property directly. "But it's an illiquid asset; it requires significant capital to go into the market, and to get fully diversified," he says.

It is as a result of the shortcomings of these two options that unlisted property funds - which invest directly in bricks and mortar but diversify the property base - have proliferated. He predicts further growth in the sector.

Global REIT funds are an interesting proposition, he says, and they will have advantages over property shares, but there are still benefits for investors in going more directly into property.

Drawbacks of REITs include the fact that the investor is still investing in the skill of a management team, and the fact that they typically have a high level of gearing.

In developing SEI's fund of funds, McCarron has turned towards the increasing number of unlisted property funds which are specialist rather than the bulk of offerings which are generalist. Over the last few years, funds have been launched that focus exclusively on retail property, industrial property or office buildings, for example. Some have even rooted themselves in the less traditional real estate types such as healthcare.

"What I found appealing, was that if we were to offer these through a fund of specialist funds, this would allow us to position the portfolio moreclearly, taking advantage of the specialisms and adding value by moving up and down that specialist scale," he says.

But Pellicer warns that with no established secondary market, funds of unlisted real estate funds are not liquid in the way that stocks or bonds are. "You can get out, and you do have some guarantee that you can have your money back, but it is not as quick as with a REIT, for example - it may take up to six months."

If the market is in the doldrums, the manager may have to sell some of the buildings within the portfolio in order to give investors their money.

McCarron says there is a small secondary market being developed in the UK for property unit trusts. "On the whole this is positive because it allows a

little more liquidity into this market."

Investors buying into funds of unlisted property funds must assume that they will remain invested for between five and seven years. "You should not assume you can sell it," says Cooper. "Certainly that is not the way we operate."

Although there is a reasonable volume of trade in the secondary market in the UK, most of the activity is at the primary end.

The illiquidity of unlisted property funds is one of the complications of investing in them, and for investors who are making their first steps into the asset class, it is better to start with listed vehicles, says Barry Sagraves, chief executive of Northern Trust Global Investments.

"The problem with investing in unlisted funds is valuation," he says. "If you have something which doesn't have a daily valuation, then you start

getting into liquidity issues."

"I would say it's more complicated than investing in listed vehicles," he says. "Both sorts of investment have a place in people's portfolios depending on where they are in their investment in property."

From the perspective of an unlisted property fund manager, Pellicer says that fund-of-fund managers can be a mixed blessing. With closed-ended funds, there is no problem, because investment is designed to stay in place for five to eight years in any case and it is very unlikely that they would exit early.

But with open-ended funds, fund-of-funds managers may try to enter and exit more quickly than that. So while they introduce liquidity to the fund they also add an element of short-termism, which can be worrying for the fund managers.