The driving principles behind investing in property vehicles

Syndicated Investments:There is no end of property investment vehicles out there, but investors should bear in mind the basics of investing in property, says Bill Nowlan

Several questions from clients and friends about Eddie Hobbs' "Brendan Property Vehicle" and other syndicated schemes prompted me to set out some simple yardsticks that should be used in assessing property investment vehicles.

I claim some competence in this area following 27 years running Irish Life's property investment portfolio and my recent 13 years as a consultant property asset manager. In approaching this I always use the letters "T A L I P".

"T" is for timing and taxation. Timing is by far the most important factor in making successful property investment. Any one should have been able to make money in property over the past 10 years in Ireland or in most of Europe in what was a most benign economic and financial environment.

Property in Ireland almost quadrupled in value in that period with some sectors above that rate and others somewhat below. The Jones Lang LaSalle (JLL) Irish property capital value index rose by 250 per cent from 1995 to 2005 - equating to an average annual return of 13.34 per cent and this excludes income earned.

However, for those of us managing property investments between 1985 and 1995, the JLL index only rose by 28 per cent which equates to an average annual increase of 2.48 per cent. What the next 10 years will bring I do not know but I would say that capitalising yields in Ireland and Europe are now at an all time low which will almost eliminate the opportunity for further yield compression and an investor will have to rely solely on rental growth for performance. Indeed, it is this compression in yields over the past 10 years that has given up to 80 per cent of the value growth in that period.

"T" is also for taxation. Property is very susceptible to taxation by government. The buying of property attracts stamp duty: 4 per cent in the UK; 9 per cent in Ireland; and in some European countries as high as 12 per cent.

There is nothing to destroy value like high transaction costs, including stamp duty, particularly if you are investing for the short term. If the underlying property does make good capital gain one has to think of capital gains tax.

There is little point in making money from a risky investment and then handing up to 40 per cent of it to the government in the form of a double whammy of capital gains tax (within the investment vehicle) and then in the hands of the individual investor.

This is why most investors like to buy in their own name rather than through a limited company. The problem is that a limited company pays CGT on its disposals and then the investor pays income tax on dividends and CGT again on the cash realised from selling his shares.

Some investment managers claim to be able to eliminate the first layer of corporate tax by fancy footwork or smoke and mirrors and some have been successful. But governments are continuously blocking these routes and, with property being a long term investment, one can be a sitting duck for the taxman's posy. I have discovered this the hard way over the years.

"A" is for alignment. The manager of the fund must have his interest 100 per cent aligned with the investor and this includes entry and exit costs. If the manager's remuneration package is not fully aligned with those of the investors, then watch out for trouble. The manager should ideally be capable of being fired by independent persons representing the investors in much the same way as independent directors can fire the officers of a PLC who are not performing.

If the manager of a property fund has secured a sweet deal - come what may - at the expense of the investors, then watch out. This alignment issue is critical.

"L" is for location. The old adage of location location location is as true today as it was 100 years ago. The location issue can be location in a country, a city, or street. The skill of the manager is in selecting the right location for an investment and the timing of that investment is paramount.

There are good stock pickers and bad stock pickers. Beware the manager whose approach to location and purchasing is to fly into a foreign city, be wooed by the local estate agents and buy the local agent's recommendation. Agents are brokers and not asset managers!

"L" is for luck and liquidity. Just like Napoleon wanting lucky generals, I like lucky managers - but ones who have proven their luck by their considered decisions and not by chance or being in the right place at the right time. Investing in property is not like just picking a horse with a pin. That luck should be supported by detailed research of the markets and the locations that are eventually chosen. Indeed no amount of luck can overcome bad timing or an economic downturn.

"L" is also for loan, leverage and liquidity. The big money made out of property investment is by leveraging up your equity by way of a loan secured on the asset. From the simple house owner with a building society mortgage to the property tycoon - all know about this concept. When property values go up, your loan remains fixed and, hey presto, you have made money by just being at the party.

What is forgotten sometimes is that leveraging can work in reverse if property values fall or if interest rates rise above the income stream from rentals.

This happened in Ireland to some small extent in the late 1980s and to a large extent in the UK in the early 1990s, and many property investors and owners can tell the tale of having negative equity in their holdings and having to take the pain of paying interest on a loan greater than the value of the property or, if selling, to cough up the difference.

If investing in a property vehicle, it's essential to look at the small print and make sure that any borrowings are non-recourse to the investor. That means that the property is the sole asset that the bank can call upon if the worst happens and the investment fails, so that the worst case scenario is that you may loose your equity but not your house!

Liquidity is the other factor. Or, in other words, the method of exiting your investment either at the end of the investment period or perhaps earlier. When looking at participating in a property syndicate it is very easy to forget that the underlying asset is property which is intrinsically a long term investment and may be unsaleable at a reasonable price for a long period.

The advantage of owning a property directly is that you can decide to sell whenever you want. If you own shares in a quoted public company you can sell the shares. But, if you are in a syndicate or an unquoted investment vehicle, one can get locked into the asset until the investment manager disposes of the properties. For the small investor this can be quite a problem and needs very careful consideration, especially if you are at, or past, middle age.

"I" is for interest rates and income. Many people seem to think that the fundamentals of property are about capital gain and forget about the income side of the equation. In a period of what I would call "normality" it is rental income that pays the pension or the mortgage. History shows that good property investment is characterised by a long period of steady income flow with occasional sudden increases in capital value. This may be very boring stuff but generally good property investment is boring - collecting the rents and keeping the customers (tenants) happy is what property investment should be about.

"P" is for passion and people. Successful property investment is about the people who are selecting, managing and then selling the assets. If the people behind the syndication don't have the passion, fire and commitment to make it happen, then don't invest with them.

In selecting an asset manager look into their eyes and see if there is a burning desire to achieve. If not, then maybe he/she is only a deal jockey who wants a deal fee.

And, finally, just remember that all investment has its risks and property investments can go wrong, particularly if there is a significant degree of gearing. You can loose all your money. On the other hand, as shown in this newspaper's recent reports on successful property developers, most millionaires have got there by real estate investment and development.

Bill Nowlan is a chartered surveyor and town planner and has run a property asset management advisory consultancy firm for the past 13 years