Actuarial Investments

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Actuarial Investments

• Shane Whelan
• L527

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Description of Key Markets

• - The Property Market
• II of II

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Industrial Property

• Smallest in unit value, not flexible in use.
• Rents linked to strength of manufacturing for
  small and medium sized companies that use
  industrial units.
• Prime here is well-placed for transport and close
  to a suitable supply of labour.
• High rental yield because
• supply responds fast as cheap and quick to build.
• They become obsolete more quickly.
• Fabric of builing deteriorates.
• Site value low.
• Cyclical industry recession, possible void that
  is hard to fill as bad time and property not
  suitable to many tenants.

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Industrial Property

• Scope for rental growth limited.
• Few comparables.
• Depreciation high

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Sundry Property Types

• Warehouses similar to factories but labour
  supply not important but transport is crucial.
• Shopping centres
• Big
• Limited marketability
• Concentrated risk.
• Agricultural forestry
• Dependent on Government policies.
• Residential
• High management costs
• Poor image of landlords (and institutions)
• Poor quality tenants, tax disadvantage, political
  interference

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Freehold Leasehold Investments

• Freeholder the ultimate owner in perpetuity.
  His rights on property are limited by
• Terms of unexpired lease
• Easements
• Covenants
• Building regulations
• Statutory requirements on usage, etc.
• If no lease on property then freehold is said to
  be unencumbered. Otherwise it is said to be
  leased.
• Leaseholder rights over property limited by all
  limitations on the freehold plus those extra ones
  imposed in the lease e.g., type of use, hours
  of usage, maintain in good condition, etc.

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Freehold Leasehold Investments

• On reversion to the freeholder after a long lease
  the property can (v. unusually) have a negative
  value so put it in head lease that it must be
  in reasonable condition at the expiry of lease.
• Freeholder is unique but there can be multiple
  leaseholders ground lease, head lease,
  sub-leases.
• Hence a holder of a sub-lease can have a highly
  geared income stream paying rent on the lease
  and receiving rent from the tenant she leases to.
  The difference between the former and the latter
  is called profit rent.
• As term of lease , and rent is low
  (relative to rack rent) and fixed then leasehold
  interest approximates an unencumbered freehold.

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Freehold Leasehold Investments

• Leaseholds are like a geared annuity-certain, and
  their value depends on the term an likely profit
  rent.
• Leaseholds are generally less marketable than
  freeholds.

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Major contents of a lease

• The parties to the agreement.
• The commencement
• The length of the lease.
• A clear description of the property, with any
  easements.
• The amount of rent to be paid and its frequency
  e.g., monthly, quarterly, annually.
• Rent review period and how to settle a dispute.
• The use to which the property can be put, who is
  responsible for repairs, insurances, and other
  expenses.
• Break clauses may be included tenant may
  relinquish lease after a given period of years.
  This gives a form of periodic lease or
  automatically renewable lease (or tenancy).
• Other covenants restricting its use.

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Finance for Property Investment Development

• Institution maybuy the freehold or leasehold
  interest in property and then let to tenants.
  However there are other methods
• Mortgages make long-term fixed rate mortgages
  available to commercial property investors.
• A fixed interest investment, yielding above gilt
  of similar duration.
• In 1871 over half the assets of life offices were
  in mortgages, falling to 10 in 1905 where it
  remained until the 1970s.
• Sale Leaseback the owner (and occupier) sells
  the property to an institutional investor and
  leases it back. Usually the sale price and rent
  is under going market rate.
• Development finance co-develop a property with
  a property developer, taking an equity interest
  so that the profits are split.

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Other (i.e., Indirect) Ways to Gain Exposure to
Property Market

• Property shares shares in property companies.
• Have substantial portfolio of properties with
  rental income which helps fund development costs.
  Their aim to be maximise NAV (net asset value).
  Subdivide such companies into
• Development
• Investment
• Trading
• Pooled property funds unit trusts.

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Direct Property -v- Property Shares

• Advantages of direct property
• Control you have total control.
• Direct property price movements are more
  uncorrelated with stock market than property
  company shareshence give greater portfolio
  diversification.
• Taxation may differ, especially for gross
  investors like pension funds who would otherwise
  not be subject to tax.
• Loss on forced sale property company may have
  distressed sale of assets.
• Management expenses may be higher and these may
  not be allowed for in share price.

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Direct Property -v- Property Shares

• Disadvantages of direct property
• Need big fund to achieve reasonable
  diversification as individual properties chunky
  investments.
• Market price and transparency in property co.
  shares good for unit funds and performance
  valuation.
• Marketability higher with less expense than
  direct properties.
• Management expertise own property staff and
  consultants is costly and time-consuming.
  Property co. comes with breadth of management
  (maybe out-paying property departments so getting
  the best?)
• Property companies can develop large properties
  than even a very large institutional fund could
  not consider.
• Property shares better way to gain exposure to
  niche or specialist areas in property market.

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Other Factors distinguishing Property Shares from
Direct Property

• Gearing property companies generally borrow to
  invest more than equity capital in the market,
  financially gearing the returns from the property
  market.
• Discount to NAV property shares are usually at
  a discount to NAV hence buying the underlying
  assets cheaply.
• Both of these factors increase the variance of
  return from property shares relative to direct
  investment and should therefore be expected to
  increase the expected return. Discuss.

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Comparison of Property Unit Trusts to Property
shares

• Taxation Property UT will reflect taxation
  status of investor hence being more tax efficient
  than property shares.
• Price stability Property UT valued at NAV while
  property shares priced by demand meeting supply
  on market (which is very loosely anchored by
  NAV).
• Marketability property shares are always
  tradeable but property Uts may temporarily be
  closed.
• Liquidity requirements property UT generally
  have high liquidity, limiting the exposure to the
  property market.
• Differences in expected returns?

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Completes Description of Property Market