Why 2018 is the year you should diversify your real estate portfolio

Property will always be a sensible investment asset. However, the choices available are changing as the ebb and flow of appetite, risk and reward in this “alternative” asset class opens up new opportunities and closes others.

Real estate is the third largest asset class in the average family office portfolio and 14 per cent of Hongkongers are planning to invest their disposable income into property in 2018, according to Schroders.

However, many may not recognise how the class is evolving and what that means for their property investment strategy.

Residential property has long been the stalwart of reliable overseas investments and in markets such as London, Hongkongers have led the way. In the first quarter of 2017, they became the biggest investors in the UK property market.

However, the benefits of residential property investments can soon disappear with regulatory and legal changes.

Children’s education drives Chinese demand for UK property

This year, many overseas investors with UK property will feel the impact of the Bank of England’s decision to raise the base rate, cutting into yields. Mortgage interest will only be tax deductible to the basic rate of tax (20 per cent) and additional buyers’ stamp duty will apply to new investment property purchases (3 per cent). All individual overseas investors will be subject to 40 per cent inheritance tax on their property beyond the applicable nil rate band of £325,000 (US$438,700).

Rents are not expected to climb more than 2 per cent, according to JLL. On top of that, the usual burdens of residential real estate still exist, regardless of how good your letting agent is.

When you want to exit residential real estate, you require market conditions to continue to be positive to realise a capital gain. And the new buyer will need to believe that the asset holds prospects for further growth.

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Property Reits (real estate investment trusts) have long been popular in Hong Kong. It is a highly liquid, easy to exit method of gaining income and capital exposure in the real estate market.

However, its liquid and tradeable price reflects investment sentiment not necessarily the underlying real estate value. Unexpected events can trigger downward shifts in net asset values and illiquidity in the market. These are equity market risks, not those that typically face a real estate investor, particularly one who wants the lower volatility and underlying asset value inherent in property.

A growing trend is higher “institutional grade” real estate investments that are attracting the interest of non-institutional investors such as high net worth individuals (HNWIs) and family offices.

There is a gap in the market to access institutional grade assets that are typically liquid and can be transparently valued.

Co-investing with like-minded investors through specialist asset management firms, the capital pool – typically between US$5 million and US$50 million – allows them to target property opportunities that have historically been accessible to institutional investors only and yet are below the target value that institutional investors require to make a difference to their investment mandate.

On a project by project basis, HNWIs and family offices can repeatedly invest into the same subclass of real estate before they are packaged up to sell into a highly competitive institutional investor market.

This is a promising niche area in property investment and one that allows professional investors with about US$500,000 to invest to be part of a property development from the ground up.

The best sectors of real estate to consider are health care, purpose built student accommodation (PBSA), retirement housing and the emerging co-living rental accommodation sector.

Student housing looks like a good bet while the undervalued pound recovers

For example, take PBSA in the UK as compared to Reits and residential property. There has been consistent growth in the student accommodation market in the UK whilst Brexit has shown how major events can impact the net asset value of Reits and the broader residential property market. 

PBSA rental income grew about 3 per cent per year and the demand in this asset class resulted in healthy capital appreciation as institutional investors were prepared to pay higher net income multiples through capital value compression. 

As such, investors reaped the rewards of a superior return but of equal importance, they truly invested in the underlying asset and in a sector not correlated to the market.

Make 2018 the year you consider how best to structure your real estate investment portfolio in light of constantly evolving markets and new opportunities.

Peter Young is chief executive of Q Investment Partners