Property in a portfolio

Property is the largest asset most households own, and it is frequently excluded from any consideration of asset allocation.

The home

Which is an asset and a place to live simultaneously.

For most households it represents a substantial proportion of net worth, frequently the majority.

It is undiversified, illiquid, geographically concentrated, and typically leveraged through a mortgage.

Which means that anyone with a mortgaged home already has a large, concentrated, leveraged position in domestic property before considering any investment.

Excluding it from the allocation picture, as most people do, produces a substantial misunderstanding of the actual position.

Whether a home is an investment

Contested and worth thinking about.

It provides a return in the form of accommodation not paid for in rent, which is real.

It has costs that reduce the return: maintenance, insurance, taxes, transaction costs on purchase and sale, and mortgage interest.

Long-run studies of house price growth after inflation find real returns that are positive and considerably lower than the headline price appreciation suggests, once costs are accounted for.

Leverage amplifies both gains and losses.

Which means a home is best understood as consumption with an investment component rather than as an investment.

Buy-to-let

Where the analysis is different.

It is a leveraged, concentrated, illiquid business with tenants, regulation and maintenance.

The returns come from rental yield and capital appreciation, and the costs from mortgage interest, maintenance, voids, letting fees, insurance, taxes and regulation compliance.

Tax treatment has become substantially less favourable in several jurisdictions in recent years, including restrictions on interest deductibility and higher transaction taxes.

Regulatory requirements have increased in most markets: safety certification, energy efficiency standards, deposit protection and licensing.

Which means the returns available now are frequently lower than the returns that built the reputation of the asset class.

It is a legitimate investment and it is not a passive one.

Listed property

The alternative.

Real estate investment trusts and property funds provide exposure to commercial and sometimes residential property without direct ownership.

Advantages: liquidity, diversification across many properties and sectors, professional management, and small minimum investment.

Limitations: listed property behaves more like equities than like direct property in the short term, since it is priced by markets rather than by valuers.

Which means it provides less diversification against equity falls than people expect.

It is also already included in broad global equity indices, which means holding a global index fund already provides some property exposure.

The liquidity problem

Which has caused real difficulty.

Open-ended funds holding direct property face a structural mismatch: investors can redeem daily while the underlying assets take months to sell.

Several such funds have suspended dealing during periods of stress, trapping investors for extended periods.

Regulators in some jurisdictions have consulted on or introduced notice periods to address this.

Which means direct property funds carry a liquidity risk that is not visible until it matters, and listed vehicles avoid it by being traded on an exchange.

The diversification question

Whether property adds anything.

Direct property has historically shown lower correlation with equities, partly genuinely and partly because appraisal-based valuations smooth reported returns, which understates true volatility.

Listed property correlates more closely with equities.

And for a household already owning a home, additional property exposure increases concentration in an asset class they are already heavily exposed to.

Which is the practical conclusion: most homeowners do not need additional property exposure, and renters have a stronger case for it.

The costs people omit

For direct ownership.

Transaction taxes on purchase, which are substantial in many jurisdictions.

Legal and survey costs.

Maintenance, commonly estimated at a percentage of value annually and frequently underestimated.

Voids and tenant turnover for let property.

Management fees.

Insurance.

Selling costs.

And the value of the time involved, which is not zero.

The practical position

A reasonable summary.

Count your home in your overall asset picture, even though you will not sell it.

Recognise that a mortgaged home is a leveraged concentrated position.

Do not add substantial additional property exposure without a specific reason.

If you want property exposure, listed vehicles are simpler and more liquid than direct ownership.

Treat buy-to-let as a business rather than an investment, and cost it accordingly.

And note that a global equity index fund already contains property companies, which for most investors is sufficient exposure.

General information only, not investment advice. Investments can fall in value and property is illiquid. Consult a regulated financial adviser and a qualified tax adviser.