In property we trust

By BRENT SHEATHER

There are probably as many views on how best to invest in property as there are types of property.

You can become an expert by reading a book, going to a seminar or mastering the basics of "negative gearing". Here is a safe, easy way.

Property is particularly attractive to many Mum and Dad investors because it is tangible and has a decent yield.

After all, if you have $100,000 then the 2 per cent or so dividend from international shares isn't going to go far - and that is before fees.

Property, on the other hand, endures, it isn't going to go out of date overnight and yields upwards of 8 per cent.

Despite these attributes a good many New Zealanders have come a cropper investing in property, probably because its nature and familiarity makes investors complacent and they put to one side basic issues like diversification and valuation.

Many of the property investment vehicles popular in New Zealand in the past have consisted of one building leased to a few tenants in one town, in one sector, in one country.

While investors will carefully diversify their sharemarket risk by investing in three or four managed share funds, when it comes to their property portfolio those same investors often forget the diversification rule and put most of their eggs into one or two baskets.

Similarly, these same people cheerfully accept the property valuation - often obtained by the promoter - at which they buy their share of the building. It doesn't occur to them that a different valuer could come up with a quite different valuation using different assumptions.

The diversification rule might seem obvious, given that it is standard practice for a share portfolio, but the way in which property should be valued also has parallels with shares.

That's because property dances to substantially the same tune as shares or, for that matter, any other asset. As always the foundation is cashflow.

When valuing a company, analysts calculate net cashflow after expenses. Commonsense, right? Not when valuing many unlisted property investments. Most valuers do not differentiate between a building with no management overhead and a building held in a trust where half the rent disappears in fees.

I looked at a property trust last month where the assets are earning about 7 per cent but 3 per cent goes in management fees. The directors agonise over why its shares trade for about 35 per cent less than valuers say they are worth.

What is needed is a truly independent pricing body. The closest thing we have is the stockmarket.

For all their shortcomings, stockmarkets - even our local one - perform a vital function: truly independent price discovery.

If, like most smaller investors, you don't have a clue whether IBM shares are worth $100 or $5 you can benefit from the price discovery function of the stockmarket, which values IBM independently every day on the basis of the interplay of hundreds of buyers and sellers, all of whom have a powerful incentive to value the shares properly.

Admittedly, stockmarkets are prone to get carried away (upwards or downwards) from time to time, most recently in over-valuing technology stocks.

But for the good majority of stocks the market price represents a fair view of reasonable value. A fair and unbiased view mind, not necessarily a correct one.

Fortunately stockmarkets don't just trade technology stocks. Most have a substantial property sector where every day blue-chip property assets of just about every type are bought and sold at prices determined by the interaction of hundreds of players, including a good number of experts.

The attraction of a stockmarket listing is that you have many independent teams of experts - most working for institutions, or the odd stockbroker - who value the asset, taking into account both the cashflow generated by the properties and the cost of the management contract.

A few years back, many unlisted property funds were deathly afraid of pursuing a stockmarket listing because they knew the market would punish the prices of their funds because of their costly management agreements.

Stockmarket listings also mean that the property assets are priced continuously, not once every 12 months.

This is rather important when you have major events such as September 11; hotel stocks in the United States fell by 40 per cent that month.

Another useful idea when buying property - or any asset - is to have a look around to see who else thinks the building(s) are attractive.

Or, in other words, who will be your co-shareholders. If they are predominantly Mums and Dads, their knowledge of the property market could well be similar to your own.

But if you see investment giants like Fidelity, AMP and Deutsche Bank on the register, that implies that they have done the research and have decided that the property portfolio and its management makes sense to them.

The shareholder lists of most of the large stockmarket-listed property funds here and overseas are dominated by institutions.

So to summarise, a good property strategy is:

* Diversify widely by sector, by country and by manager.

* Stick to listed property stocks.

* Check out your co-shareholders.

Enough of the strategy, what to buy and how?

Three of the world's biggest securitised property markets are in the US, Britain and Australia.

The US has the biggest property market in the world, accounting for roughly half of the global securitised property market.

Just about every possible type of property is listed - apartments, shopping centres, offices, industrial buildings and even prisons.

The big attraction of the US is something which has been very rare in New Zealand - rental growth.

Yes, rents have moved steadily higher in the US over the past 10 years thanks to a strong economy, although things are slowing down now. This has been translated into steadily increasing dividends.

If you had bought shares in the largest apartment trust in the US five years ago, today you would be earning 16.8 per cent a year in dividends on your original investment.

And if you are looking for bargains, well right now you can buy one of the world's biggest hotel owners, Host Marriott, for below half of the replacement cost of the buildings. One problem though, it cancelled its dividend last month.

The best way to buy property in the US is probably via an index fund. There are a number of such funds, some of which are listed on the New York Stock Exchange.

My favourite is the Dow Jones US Real Estate Index Fund, which owns about 100 of the biggest property companies in the US and yields about 6.5 per cent.

With one stock you get exposure to more than five million tenants, with your funds spread among apartments, offices, shopping centres, industrial buildings and so on.

In Australia and Britain the choice is not as wide as in the US but in Australia particularly there are some great yields. For example, the AMP's specialist industrial property trust yields income of about 10 per cent, plus some growth, and all shareholders need do is bank the cheque.

It is relatively easy to purchase overseas property funds. Most local stockbrokers and financial advisers can do so, through relationships they have with overseas brokers. Additional charges payable to the overseas broker are typically about 0.5 per cent of the amount invested, on top of whatever the local broker or adviser charges.

As with any overseas investment, there is the possibility that adverse currency movements can reduce your returns; if the kiwi dollar rises relative to the US dollar, for example, the value of an investment in a US-based property fund will be reduced.

That risk is ameliorated somewhat by the fact that many of our day-to-day living expenses are denominated in overseas currency, which means that a rise in the kiwi dollar - while it may hurt investment returns - reduces the cost of living.

Also, if you intend spending some of the worst of the New Zealand winter overseas, the credit card bills are a little less painful when you know that your overseas property dividends pay for some of these luxuries.

Closer to home, the local sharemarket features property stocks such as Kiwi Income, AMP Office Trust and Property For Industry (PFI). While these shares pay high and stable dividends, none has been able to produce much growth in earnings per share, partly because of the sluggish local economy. However, both Kiwi and PFI have outperformed the return on Auckland housing - as measured by the Auckland metropolitan house price index - over the past five years.

The securitised approach is easy, low maintenance and - barring a depression - guaranteed to perform. It also takes less time than reading one of those books.

* Brent Sheather is a Whakatane stockbroker and investment adviser.

* Disclosure: Brent Sheather owns shares in: Kiwi Income Property Trust, AMP Industrial Trust, Westfield Trust and i-Shares Dow Jones Real Estate Index Fund.