Many people aspire to owning their own home one day, but owning investment property – property that is not your primary residence – can be a good way to generate passive income (i.e. income that doesn’t require lots of work to make it).
In episode four of the first season of the Unpacking Wealth Creation podcast series, Investec Wealth & Investment fund manager Marc Fellner and portfolio manager Kyle Lasarow unpack the topic, including what listed property is and how it can offer you exposure to the asset class without owning the physical property yourself.
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What is listed property?
Property companies that develop and manage property can be listed on the stock exchange, enabling you to invest in their shares. In this way, you can get exposure to their significant property portfolios, but you’re only taking on equity-like risk rather than the risk of buying physical property yourself.
How should I think about listed property?
You’ll know from previous podcasts that it’s important to diversify your portfolio. But how is this possible from a property investment perspective? Not many of us have the means to buy multiple properties in different sub-sectors or geographical areas, so we land up buying a single property, say to rent out, and take on a fair amount of risk, including tenant, location and exit or liquidity risks. Not only do you take on the risk that tenants fall behind or default on their rent payments, you also risk that the property’s location becomes less desirable or that you can’t exit the investment quick enough (property is considered a relatively ‘illiquid’ asset which means you can’t buy or sell it instantaneously, like you could with, say, shares).
Fellner explains further: “They say residential property is all about location, location, location. But obviously this can play against you because if you get the location wrong and you’ve got a single asset as residential property, you may find yourself in trouble.”
Lasarow adds: “It’s also important to consider that there can be a time delay between when you want to sell your property and when can actually sell it. You’ve got to find a willing buyer and the value of your asset is only what someone else is willing to pay for it.”
Fellner suggests considering listed property as way to get diversified exposure to property without some of the risks associated with physical property investment. “It’s much quicker and transactionally easier to buy into a listed property structure than it is to invest in bricks and mortar. A listed property structure will hopefully provide you with a highly competent and incentivised management team that makes the property investment decisions for you. Through their scale and aggregation, these big listed instruments can acquire significant property portfolios.”
While a listed property company can offer its own diversification benefits – say it invests in residential, office and data centres – you can also do your own diversification by holding a variety of property investments. “For example, owning a portion of a shopping centre and a portion of a self-storage asset through a listed structure could help you counterbalance some of the risks associated with each subsector," explains Fellner.
What are some of the property subsectors that listed property can offer access to?
“One of the most exciting things about the property sector is how differentiated it is," says Lasarow. "There are so many different subsectors and so many different things affect different types of property holdings.” For example, there’s residential property, which is being affected by the ease with which people proved they could work from home during the pandemic.
Lasarow points out, you don’t have to live in the big city centre to be close to work anymore. “You can work just as easily on the coast in a small town and work for some of the biggest companies in the world.”
But this has had a significantly negative effect on the office subsector, which has been under a lot of pressure as a result of the shift to working from home. Fellner explains: “I’m not saying the office space is dead and will never come back, but you may have missed the opportunity to benefit when the subsector did well if you weren’t diversified in your portfolio.”
The pandemic also had a big impact on the hotel subsector. “Hotels took a knock during the pandemic because tourism dried up. But data centres have done well because data usage was extreme," says Lasarow.
How can I get offshore property exposure?
While diversification between investments and subsectors is important, it’s also useful to have some geographic diversification. How can we achieve this from South Africa?
Fellner elaborates: “We’re very fortunate in South Africa that we’ve got a large listed property sector and it offers good diversification among the retail, office and industrial subsectors. Importantly, these companies have made big acquisitions over the last decade into international assets. This means you can access offshore assets through onshore listed structures.”
Lasarow however warns about the impact of currency risk: “If your property investment is earning some of its return in euros, and some in rands, it’s a very different investment situation to one in which you only earn rand returns. So, you must take that into account when you build your portfolio.”
What is inflation?
Inflation is a general rise in the prices of an economy’s goods and services.
What role can property play in protecting against inflation?
“As inflation rises, you tend to see property companies increase rents, which leads to an increase in your dividend yield and protects your income from inflation," says Lasarow.
Fellner adds: “Also, the value of your asset is determined by its replacement cost. In an inflationary environment, the replacement cost of your bricks and mortar will also rise, thereby protecting your capital from inflation too.”
While property’s inflation-hedging characteristics are particularly pertinent in today’s world, where inflation is at multi-decade highs in many parts of the world, Lasarow argues that property has always, and will always be, a relevant asset class: “Property is one of the oldest asset classes in the world. Two thousand years ago people were talking about buying houses and business, and it’s just as important today. Property will always be relevant, not least because it will always be a real asset that you can see, feel and touch. A lot of people find that very comforting in today’s world of intangible assets.”
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