Not yet at peak
I n recent years, limited partnerships (LPs) and property unit trusts (PUTs) have become popular in the UK. Over the last four years, pooled property vehicles (which we define to include both LPs and PUTs) have nearly doubled in size. Indeed, according to our estimates, at the end of 2002, the total value of property held in pooled property funds (LPs and PUTs) exceeded the market capitalisation of the quoted property sector.
Within institutions, these vehicles are more likely to be held by the property fund managers than their equity counterparts because the assets’ performance is more closely correlated with direct property than with property shares.
There are great variations in the nature of property LPs. Some are simply convenient structures for two or three investors to hold properties in joint venture, while others are genuine collective investment schemes. Clearly, the former are not intended to available to the wider investment market, so we will concentrate on the latter.
Although LPs formed under the 1907 LP Act in the UK are fully tax transparent and thus themselves pay no tax on their income or capital gains, the introduction of new partners may result in taxable event for the existing partners. Stamp duty at up to 4% is payable on the transfer of a partnership interest, depending on the structure of the vehicle.
Currently, there is no active secondary market in LP interests. This is for a variety of reasons, including the creation of a potential tax liability on the admission of a new partner, the pre-emption rights of remaining partners in many partnership structures, and the bespoke nature of these structures that necessitates a lengthy due diligence process required of a potential new investor in an LP. This means that existing interests are typically marketed in the same way that property is marketed and, often, a firm of surveyors is employed. In our experience, many of the sales of interests are, however, to existing partners.
The two principal categories of PUTs are those which are authorised (and which are designed to appeal mainly to retail investors) and those which are unauthorised (and which generally are open to investment only by institutional investors).
There are currently only two authorised PUTs: the Edinburgh Property Portfolio and the Norwich Property Trust. Authorised PUTs are open-ended, with their managers quoting prices, on a daily basis, at which they will issue new units or redeem existing units. Transfers of units are subject to stamp duty at 0.5%. They may not gear, and are required to hold a proportion of their assets in cash and other liquid investments to meet potential redemptions of units. The gearing/cash-liquidity is perhaps the greatest impediment to the growth in Authorised PUTs, given the obvious yield gap in today’s market.
Being generally available only to institutional investors, unauthorised PUTs are subject to fewer restrictions than authorised PUTs. They fall into three categories: exempt, non-exempt and offshore trusts.
o Exempt PUTs are available only to investors (such as UK pension funds and registered charities) that are not subject to CGT other than by reason of their residence. They are open-ended, with fixed dates on which the manager will issue and redeem units. This is usually monthly or quarterly, but not daily, as with authorised PUTs and managed funds. Exempt PUTs may be either balanced (ie diversified) or specialist funds. Transfers of units are subject to stamp duty at 0.5%.
o Non-exempt PUTs are similar in most respect to exempt PUTs. The main difference is that while subject to restrictions on marketing to the public, they are open to investment by both exempt and non-exempt investors.
o Offshore PUTs are resident outside the UK, most commonly in Jersey, Guernsey and Ireland. Like onshore unauthorised PUTs, they are not available for marketing to the general public in the UK, although they are usually available to financially sophisticated, high net-worth individuals. Most, although not all, offshore PUTs are geared, and the majority are specialist as opposed to balanced or diversified funds. Some offshore PUTs are closed-ended, ie, there is no obligation on the manager to redeem units as in the case of an open-ended PUT. The managers of closed-ended funds thus do not publish bid and offer prices, but rather the net asset value of the trust units (usually on a quarterly basis). Units in offshore PUTs can be traded outside the UK with no stamp duty cost.
Most of the turnover on the secondary market is facilitated by PUT managers themselves by matching sellers from buyers from within their own investor base or new enquiries (possibly as a result of a marketing exercise). There are, however, other players in the market, most notably HSBC (which operates a matched bargain service on behalf of its institutional clients in most PUT, managed and common investment funds) and Cazenove (which operates a matched bargain service in Hercules Property Trust units).
The chart provides some indication of market liquidity: it is drawn from data compiled from members of the Association of Property Unit Trusts, and shows the three measures of market activity as a percentage of the total offer market capitalisation of the members’ funds on a quarterly basis. How one interprets these figures depends in one’s definition of liquidity. Summing the figures for December 1998 (the peak), for instance, produces transactions of £382m (E541m), or 6.9% of the market capitalisation. Over the total period June 98 to December 2002, the average percentage is 3.6% and converting this to an annualised figure produces 14.3%.
Because of the different measures, drawing comparisons with direct property and the quoted property market is rather difficult, but I would suggest that the liquidity of PUTs is comparable with the direct market, but below that of the quoted equity market. It is almost inevitable that the liquidity will reduce in a recession, but the same is true of most asset classes.
While most of the trades we conducted over the past year have been struck at ‘mid price’, the basis of their pricing is subject to negotiation between the parties. It will vary, depending, for example, on the fund’s expected performance and investment profile. Commission is at the rate of 0.2% to each party, with settlement after five working days. Trades are initiated by enquires from clients as to the potential supply or demand for units, or in response to a bid and offer list circulated on a weekly basis to those institutional clients that are active in the secondary market.
We believe that the investor demand for pooled property funds has yet to peak. We see property in the widest sense accounting for a greater share of net new institutional investment than it has in recent years, and believe that pooled property vehicles will continue to capture a disproportionate share of this ’new money’. Vehicles investing in specialist sectors of the property market are likely to continue to see the lion’s share of this growth.
At the same time, more property companies in the quoted sector are likely to follow the example of Pillar and Capital & Regional in converting themselves into (mainly specialist) property fund managers, transferring properties from their own portfolios (and from those of their institutional partners) into pooled property vehicles.
As it continues to grow, the market in pooled property funds is becoming increasingly transparent, with more information and independent analysis becoming available, increasing the number of potential investors. The increase in the size of the market and its increasing transparency are, in turn, stimulating activity in the secondary market in most types of pooled property vehicle.
One obstacle to further progress is the limited amount of research that is available on pooled vehicles. A joint publication by the Association of Property Unit Trusts and HSBC, and compiled by IPD, provides a quarterly tabulation of PUTs’ performance. A more-recent quarterly publication by HSBC profiles the individual PUTs. But, so far, there is no analysts’ reports on the PUTs; the problem is that there is not sufficient fee revenue to support such a venture. If, however, the market continues to grow, that is an obvious next phase.
Alan Patterson is property equity analyst with HSBC Bank in London