In My Opinion: How safe is property investment?

Posniak-Mark-CUT-2012

Property remains a sound investment — Brexit or no Brexit – but it is crucial to understand how you are investing

Property funds have been in the news a lot over the past few weeks following the decision by a number of high-profile equity-based commercial property funds — from Aviva and Henderson to M&G and Standard Life — to suspend investor withdrawals.

On the back of this, understandably, we have had a few advisers ask us whether the challenges currently facing equity-based commercial property funds might play out in other sorts of property investment too.

Advising the advisers
Essentially, advisers have been querying whether debt-based property investing is exposed to current Brexit-related nerves in the same way as equity-based property investment. Is there likely to be contagion? In my opinion, no, and the primary reason stems from the basic structural differences between debt and equity.

With equity-based property funds, both the value and liquidity of an investment are directly linked to the sale and value of the properties in the underlying portfolio.

So, in the event of a run on the fund, as we have seen with commercial property funds in the first half of July, how much you get back and how quickly depends on what the underlying properties sell for and when. It is that simple.

With debt, it is different. Returns are not based primarily on the value of the property but on the interest a borrower pays on their loan. The property is offered as security only in the event of a default. And that is where the loan-to-value ratio comes in.

Essentially, the LTV provides a significant buffer against any potential capital loss resulting from the sale of the underlying asset if the borrower defaults.

We cannot speak for other products of this kind but the average LTV of the residential loans that Dragonfly Property Finance has made for Octopus Choice investors to date is around 62 per cent. In other words, if the borrower were to default, current investors would have a buffer of about 38 per cent between them and any loss of capital.

The LTV element of debt-based property investing therefore serves as a significant cushion against market conditions.

Equity-based property funds, on the other hand, move much more closely in line with market sentiment, which, as we have once again been reminded, is not always positive.

Illiquidity
But equity-based property funds are not just more volatile — they are arguably more illiquid. Once a fund has exhausted the cash reserves it maintains to facilitate outflows, accommodating withdrawal requests means selling properties.

This is far less the case with debt-based property investments, where the sale of property is only a worst-case scenario, and where secondary markets can exist to facilitate withdrawals.

So, we believe property remains a sound investment — Brexit or no Brexit – but how you invest in it has never been more important.

Short guide: Debt versus equity

1. While they may have more upside potential, equity-based funds are directly linked to the realisable value of the underlying property assets. Debt investing uses the asset only as security, with the LTV ratio offering headroom against any fall in its value.

2. When considering investing in property debt, what is the capital preservation record of the lender making the underlying loans? While past performance does not guarantee future results, always ask for its historical default rate. This is key.

3. Are there any additional mechanisms to provide extra liquidity? For example, some debt-based managers will use their own balance sheets to inject additional liquidity or invest alongside external investors to take, where necessary, the initial hit.

4. Does the product you are considering primarily invest in commercial or residential property? Residential property tends to be less volatile and is underpinned by a deep structural supply/demand imbalance.

5. Both are capital-at-risk investments and some debt-based property investing is not covered by the Financial Services Compensation Scheme.

Mark Posniak is managing director at Dragonfly Property Finance (the lender behind Octopus Choice)