UK misses out on real estate securitisation

Copyright: David Lawson/Financial Times 1997

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Bureaucracy and fear are strangling efforts by the property industry to staunch a potentially crippling outflow of resources and restore competitiveness with other forms of investment. Plans for  US-style investment trusts and a comprehensive derivatives market may now miss the current market  upturn.

   Bricks and mortar have always suffered  as an investment medium because they are lumpy assets demanding intensive management. Prime property is too expensive for many funds and even the humblest  building takes a lot longer to buy and sell than gilts and equities. Pricing is also a problem in a notoriously opaque market.

  Such problems remained  in the background during decades of high inflation and soaring returns, but have reached crisis point over the last few years. Investors are  deserting the sector in droves. Property now forms less than 6 per cent of funds' portfolios - a third the level a decade ago. Only recently, Colonial Mutual sold its entire œ130m portfolio and Friend's Provident traded œ120m worth for shares in Benchmark, the Malaysian-backed manager. That is despite forecasts that property returns are expected to return to double digits over the next couple of years.

 One alternative to direct investment is to buy shares in property companies but this exposes exempt funds to capital gains and corporate taxes. Another is property unit trusts, which have soared in popularity. The largest, Schroder Exempt, has seen membership triple and funds grow from œ175m to œ500m in four years.

  But the market wants more. Demand for indirect vehicles almost doubled last year to 43 per cent of institutional investors surveyed by JLW Finance. The greatest effort is going into lobbying for US-style real estate investment trusts (Reits). These  are closed-end, relying on share dealing to provide liquidity for investors rather than the  potential problems open-end trusts may face reimbursing investors. They are also tax exempt - but this is also proving the biggest problem in getting them approved.

  Long-awaited approval expected in the latest Finance Bill failed to materialise because the Treasury is still unsure whether  Reits  would drain tax coffers. Pressure continues to be applied by   heavyweights like Alistair Ross Goobey, chief executive of Hermes Pension Management and a key government adviser, but chances of a breakthrough under the current government have disappeared.

 There are fears that a Labour administration might be even less sympathetic. John Whalley, head of property at the giant AMP Asset management, is less pessimistic, pointing out that  politicians of all colours will realise how crucial the sector is for planned urban regeneration. But the sector could be into its next down-cycle by then, restricting chances of success.

  Progress is being made in other areas, however. The  Stock Exchange has been quicker to react than the Treasury, changing listing rules to allow a new kind of trust. This lacks the tax neutrality of a Reit and will be open-ended but could prove a useful step in the right direction.

  Dusco, the investment management group which made the running in forcing these changes, is planning a  trust which could involve funds swapping  more than œ100m worth of shopping centres for tradeable securities. Its chairman, Dik Dusseldorp[CORRECT], who has  massive experience setting up listed vehicles in Australia and the US, has dismissed industry scepticism that he will be able to accumulate a big enough portfolio and expects trading to launch within months.

 Schroder is also understood to have teamed up with NatWest Markets to create an investment trust which achieves results comparable to a Reit without needing changes in tax laws. Investment trusts focused on housing are also being worked on, although these could face problems from the tight rules imposed on types and size of asset.

  Meanwhile, the focus on equity securitisation has overshadowed more successful  treatment of debt. The high-profile œ1.6bn purchase of the Ministry of Defence housing estate by Annington, a company created for the deal by Nomura, hinged on a œ900m securitisation. 'By selling off government risk income streams as a traded security, it was able to achieve pricing around 30 basis points over gilts,' says Rupert Clarke managing director of JLW Finance. A similar deal was done by NatWest for British Land at a margin of 40 basis points for the Broadgate office complex. Debt  securitisation like this has been unfairly overshadowed by equity securitisation, he says.

  The same  sophistication is being applied to  creation of a derivatives market, where investors can benefit from property performance without having to touch a building.  'Synthetics' like Property Income Forwards (Pifs), an over-the-counter contract,  enables investors to bet on the benchmark IPD Index rather than deal in real property.  Iain Reid, chief executive of BZW Property Investment management, says the fact that Pifs turnover exceeded œ200m - including some of the biggest institutional names - within a couple of months of launch shows the strength of demand.

  Goldman Sachs, Warburg and Citibank have also tapped this market, using  a basket of leading property company shares as proxy for the market. But the real sign that property has caught up with other asset classes will be a non-proprietary contract which can be traded on the futures exchange.

  That, too, is in prospect, with a a consortium of funds  working on proposals. Like Reits, however, the breakthrough has been held back by the network of approvals  required from the Securities and Investment Board.  Both could emerge in 1997, marking the point at which the property sector finally came of age. But fears remain that they may be delayed long enough to miss the boat.