Unit 11 Investors in Real Property Investors in Real Property Investment in real property is carried out by private persons, private trusts and the institutions—insurance companies, pension funds, charities, property companies, property bond funds and property unit trusts. To some extent each has different objectives, and so their preferences differ. Private Persons Anybody who purchases a property rather than renting is an investor. The satisfaction or return received should at least equal what could be obtained if, instead, premises were rented and the money invested elsewhere.For example, a person may rent rather than buy a shop either through lack of capital or because he considers the money can be more profitable employed in carrying stock, etc. Owner-occupiers, e.g. shop-owners, farmers and householders, are holding wealth in the form of real property. They enjoy a full equity interest—income or satisfaction from the use of their property, and normally a hedge against inflation. Other private persons investing in real property usually have only limited funds. Thus their direct investment tends to be restricted to dwellings and secondary shops. Indirectly, however, they can invest in prime shops and offices by buying property bonds or shares in property companies. Insurance Companies By and large, life-insurance companies try to match assets to future liabilities, and this largely determines the spread of their portfolios as between short and long-term fixed-interest investments and equity holdings. The post-war trend of insurance companies’ asset holdings has been away from fixed-interest securities towards ordinary shares and property.In order to give endowment and life-insurance policies an ‘inflation-hedge’, companies introduced ‘with profits’ policies. As a result, they increased their holding of property, chiefly in first-class office blocks. Most property is acquired by direct purchase, but because of a shortage of the right type of property many institutions now participate directly in development, usually in conjunction with development companies, property companies and construction firms. Insurance companies find it advantageous to own properties directly rather than through shares in property companies because: (a) direct investment in property gives the company more control than an investment in property company shares; (b) a substantial holding of the shares of a property company (necessary to exercise some control) may be more difficult to dispose of than a first-class building; (c) the prices of buildings have tended to be less volatile than the prices of property company shares; (d) the high gearing of a property company is of little advantage to an insurance company which always holds part of its assets in fixed money terms, and (e) holding shares in a property company represents an inefficient way to invest in property since corporation tax is deducted from profits attributable to dividend, whereas the insurance company pays a lower tax rate on life income.
Insurance companies still hold a part of their assets in mortgages as an alternative to fix-interest-bearing stock. Pension Funds Pension funds now compete strongly with insurance companies and property companies for first-class properties since the inflation-hedge helps to retain the real value of the accumulated pension funds. The smaller pension funds invest in property indirectly through pension fund property trusts, whose trust deeds limit membership to pension funds and charities enjoying tax exemption. Such trusts afford the advantages of property investment without management problems. The larger funds, however, prefer to purchase and manage their own properties. The disadvantage of holding shares in property companies is even greater for pension funds than for insurance companies since pension funds do not pay tax on income or capital gains. Charities and Trusts Charities and trusts are concerned not only with income (from which periodic distributions are made) but also with retaining the real value of trust funds. Consequently, although they pay no income-tax, they cannot invest entirely in high-yielding securities. For example, the Church Commissioners, who pay clergy stipends from investment income, endeavour to preserve the real value of that income by holding a part of their portfolio in equity interests, including property and farmland. Unlike most institutional investors, charities receive little ‘new’ money for investment each year. They are therefore constantly reviewing their existing portfolios to see what possible adjustments could best serve their beneficiaries, both present and future. Property Companies Property investment and development companies have grown considerable since 1945, largely reflecting the boom in urban redevelopment. Most tend to be highly geared, their capital consisting of a high proportion of loans to ordinary shares. Properties owned provide the security against borrowing, while interest charges are covered by regular rents. High gearing is beneficial to the few ordinary shareholders when profits are good, and it makes it easier to retain control. The larger companies tend to specialize in office blocks or prime shop properties, and a few in industrial properties. Residential property investment is confined mainly to smaller companies, many of which engage in ‘break-up’ operations, selling houses and flats to sitting tenants or, when vacant possession is obtained, to owner-occupiers. Property Bond Funds The person wishing to invest in property is faced with the snag of having insufficient funds to buy prime property, the kind which has shown the greatest capital growth. The property bond fund, a comparatively recent innovation, partly succeeds in overcoming this difficulty. Subscribers buy a number of units in a fund which invests the money in first-class property. Thus Abbey Life, the largest, has over $200 million invested in offices, shops and industrial property in the major cities of Britain, and also in Belgium, Holland, France and West Germany. Agricultural estates are also held. In this way the holder of property bonds has a wide spread in first-class property, with the value of the bonds varying directly with the value of the properties held. In conjunction with their agents, these funds take an active interest in the management of their properties, revaluing them at fixed intervals. Property Unit Trusts
A similar principle operates with those unit trusts which specialize in property, but in order to avoid management commitments, such unit trusts use their funds to buy shares in property companies or in companies such as hotels which are concerned with property. Building Societies Building societies can be regarded as institutional investors since they are the most important source of loans for house purchase. Questions 1. Why do insurance companies and superannuation funds in the United States invest actively in real estate? 2. Please give an example of prime property and explain your reasons.