Are Property ETFs Out Of The Woods?

Published in Investing Strategy on 10 February 2010

What should you look out for when choosing a property ETF?

I admit that property investments haven't fared as poorly as I expected since last summer. They've by no means made up for the losses of 2008, but they have recovered pretty well.

Property ETF performance

All of the five iShares property ETFs except iShares UK Property (LSE: IUKP) have shown positive returns in the last six months. The best returns were made by iShares US Property (LSE: IUSP), which rose 12.4% since last August, partly helped by the decline in the sterling/dollar exchange rate. Performances may not have been stellar but these ETFs (again with the exception of the UK fund) have also yielded dividends of over 3%.

One of the main strengths of ETFs has been thrown into relief by the halt to investor redemptions called by a number of well-known property funds, such as the New Star International Property and the Standard Life property funds. 

Property ETF investors can always liquidate their investment. But the other side of the coin should also be remembered; property ETFs, are confined to investing in property companies and real estate investment trusts (REITs) rather than directly in individual properties. It's a little-known fact that the average property prices are less volatile than the average share prices of the companies and REITs that own them.

Two property ETF drawbacks

My first reservation about some of the iShares property ETFs is that they're too highly concentrated, with Land Securities (LSE: LAND) and British Land (LSE: BLND) comprising 20% and 16% respectively of the UK fund. Unibail-Rodamco of France accounts for almost 30% of iShares European Property (LSE: IPRP). 

Such high concentrations of individual stocks mean that some research of the individual companies seems to be in order although iShares Developed World Property (LSE: IWDP) and the US fund are far less concentrated.

The second drawback to property ETFs is that they leave you in the dark about where exactly the fund constituents invest and the make up of their combined portfolio. For example, Segro (LSE: SGRO) makes up roughly 10% of the UK fund but more than a third of its property portfolio is located on the Continent. 

It doesn't feel right not knowing how much of the fund's overall portfolio is invested in retail or office space, hotels or nursing homes, in the City of London, London's West End or elsewhere. The problem with a property ETF is that it's nobody's job to put this data in front of the investor so, although it seems to go against the spirit of tracking, that's another reason that property ETFs really do require research.

And the outlook

The future still doesn't seem too bright for commercial property investments. On top of the devastation of confidence wrought by the financial crisis, come forecasts of how our 21st century way of life is going to undermine traditional areas of profit, notably telecoms promoting home-working, video conferencing and internet shopping.

That said, the demand for office, hotel and retail space is already stabilising and property investments do produce income. On this basis I'd consider in particular the European and worldwide property ETFs. The former currently has no southern European constituents although Unibail-Rodamco do have significant Spanish and central European portfolios. 

I'm less sure about iShares Asia Property (LSE: IASP). Firstly, this ETF is focused heavily on property companies based in Hong Kong (40%) and Australia (35%) and, secondly, the future of Chinese property investment seems hugely controversial. 

You can take your pick between those who argue that the level of investment in (empty) property is a monster bubble and others who are counting on a new wave of Chinese consumers to occupy it. I'm doubtful that the Chinese consumers are going to ride to the rescue soon enough.

As for the UK property ETF, some commentators have been saying that investor returns will depend on yields rather than a rise in the share price in the near and medium term but, in fact, these yields look good enough and safe enough to help the shares upwards, but not very far or very fast.

So, a tentative 'yes, property ETFs are probably out of the woods'. I suspect they'll probably provide a gradually improving income.

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BarrenFluffit 10 Feb 2010 , 12:42pm

Note that the tax position of Eire based ETF's receiving Property Income Dividends's from UK Reits is opaque. A UK resident receiving a PID has 20% tax deducted but can reclaim this eg in an ISA. As the REIT regulations force REITS's to pay high dividends and many major uk company's are reits its a relevant issue.

fuiseog 10 Feb 2010 , 7:48pm

Although you may be entitled to reclaim witholding tax on Irl based companies shares, neither Selftrade in their iSA's nor Sippdeal in their sipps will do it. This may also apply to ETF's in these tax exempt envelopes.

francisgroves 11 Feb 2010 , 3:09pm

Tax and property ETFs do indeed present a monster tangle.

PID (property income distribution) isn't applied to the ETFs directly but, presumably, is paid by IUKP. then the ETF shareholder gets 10% tax credit deducted from their dividends.

For all the other property ETFs that I mentioned, there's no PID but there may well be withholding tax payable on the constituents dividends. I took a look at the IUSP in the iShares ii 2008/9 accounts and non reclaimable withholding tax appears as an item.

The really serious problem, as I see it, is that only IUKD has distributor status (or reporting status as it's called now), which means that capital gains are treated as taxable income. The simple solution to this problem would be to always put them in a SIPP or ISA.

However, one can't help wondering if the government and HMRC are really on top of this. If you sell at the ETF shares at a profit, do all brokers specify that you've some 'income' to declare? Are HMRC staff really on the look out for small investors getting this wrong on their self assessment forms? So much for "tax doesn't have to be taxing."

I don't actually own any property ETFs myself right now but to the best of my knowledge (based on Powershares FTSE RAFI Europe ETF shares I DO own) there should be no Irish withholding tax deducted from the ETF dividends provided, I think, that the ETF shares are held in CREST.

Thanks for highlighting these issues.

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