Long faces among property fund managers greeted the change of government in the last UK general election. This was not antipathy to the new political regime, recognized as far more moderate than previous Labour administrations. It reflected disappointment that the outgoing Tories had run out of time to produce a workable system for securitising real estate.
The industry fought hard for legal changes to allow a vehicle along the lines of US real estate investment trusts, which strip away tax burdens and offer the liquidity of tradeable securities rather than the lumpy bulk of bricks and mortar.
But investment funds did not stand still. They quickly found a substitute in limited partnerships, which offer many of the advantages. These are not the limited liability partnerships being formulated for professional firms and touted as new kind of investment vehicle.
The legal framework for limited partnerships has been in place for almost 100 years but rarely, if ever, used for pooled investment. Consultants CB Hillier Parker estimate that more than £8bn has poured into these vehicles. Some observers predict this could more than double in the next few years.
The explosion of interest comes from a shift in attitude towards real estate. The economy is changing faster, making buildings appear even more illiquid and vulnerable to obsolescence. New sectors such as leisure and retail warehousing and a move to more flexible leases demand specialist knowledge and risk management. Assets are bigger, pricing themselves outside the reach of smaller funds or making too large a claim on institutions that have been forced by new actuarial rules to be more liquid.
This has led to an exodus of smaller funds and property now makes up less than 6 per cent of institutional investment compared with almost three times that level 20 years ago. At the same time, however, direct property is producing record returns of around 15 per cent and fund managers lust after a piece of this action.
'There is a great shortage of suitable property in the UK and limited partnerships have offered a way in,' says Philip Gadsden, a director of LaSalle Investment Management.
'They can access assets that would normally be too big, such as major shopping centres, or get into sectors like leisure, which are high-growth but also potentially high-risk.'
MWB saw this early, launching one of the first limited partnerships even before the election by pooling leisure parks with institutional partners. The firm is now on its third fund. IO Group has done the same for industrial property. Multi-let estates are one of the best performers in the property sector, but they are messy to manage. IO has made a speciality of taking over institutional holdings or buying up estates with pooled funds and doing the dirty work.
Other sectors are being drawn into the net, such as shopping centres, hotels and retail warehousing. The long-awaited breakthrough into residential investment has come through Charterhouse and a group of institutions.
'Limited partnerships have become an accepted vehicle in a very short time. They are part of a general move in which property funds are looking to put between 10 and 25 per cent of their holdings in collective investments,' says Brad Bauman of CB Hillier Parker, who is working on a tranche of new vehicles
But a thread of scepticism still runs through the sector. While some institutions have dived in headlong, others have held back. The Prudential is a major real estate investor, keeping faith with the sector when others have run for cover. Yet it has participated in only one partnership, the Charterhouse residential fund.
Liquidity is not a prime driving force for big life insurance funds, says Peter Peirera-Gray, director of fund management in the Prudential property division. In fact many funds are loath to lose the 'illiquidity premium' of real estate by joining pooled vehicles.
Crucial factors which have seen the Pru turn down many invitations are risk, management and asset choice. 'I am not anti-partnership. It is just that they must offer something we cannot do ourselves,' says Pereira-Gray.
Residential is a classic example. The Pru sniffed around the sector for years, keen to tap the potential of soaring capital values. But it waited until offered the right product. That hinged on the second important principle - management.
Several observers commented privately that they were disappointed by the poor quality of assets and management costs of some partnerships being touted around the market. Liquidity is also still unproven, as there has been almost no secondary market in partnerships stakes. Peirera-Gray would say only that investors 'should be aware' of hefty up-front costs which can affect initial running yields.
Limited partnerships can also be unsuitable for some projects. Some of the biggest developments ever seen in the UK have been folded into co-mingled funds but these are slightly off the main track. Fosse Park near Leicester, was moved into a Channel Islands fund by Schroder Investments to escape limitations on foreign ownership and stamp duty. Chiswick Park, a landmark suburban office development in west London, is following the same route after pulling in funds like Schroder, Equitable Life and Clerical & Medical.
David Hunter of Argyll Investment Managers, who put the development together, says a limited partnership with its relatively short life does not suit a scheme like Chiswick, which will be built in phases over a long period.
It may be shifted into a partnership later, much in the way Brindleyplace, the huge redevelopment in central Birmingham is being groomed. But Hunter is in no hurry to search for REIT solutions. He is a long-standing critic of the drive towards listed investment funds.
'The property industry is confused,' he says. 'It demands a quoted vehicle but also wants to trade at par. You only have to look at the discounts to net assets that REITs are trading at in the US to realise the problems.'
Latest moves involve exporting partnerships even further than the Channel Isles. Leading players such as MWB, IO Group PRICOA and LaSalle Investment Managers, as well as entrepreneurs like Grantchester chairman Paul Wight are looking for opportunities in mainland Europe. Tax and legal differences make limited partnerships essentially British but they can be centred on overseas property. Standard Life tested the idea last year and found that more than 50 per cent of Britain's top fund managers would be interested.
Bauman points out that if the UK adopts the Euro, this could all be academic. Investors would choose Dutch unit trusts or create vehicles which could list on an exchange such as Luxembourg without the raft of restrictions which have stifled UK co-mingled funds.
If not - and the government continues to drag its feet on legal changes for REITs - limited partnerships could become a powerful force. Analysts expect a new burst of launches this year while existing arrangements will be extended beyond their relatively short planned lives.
They may not be ideal, but this kind of vehicle could be vital to keeping fund managers interested in UK real estate
David Lawson home page