Get your foot in the des res door

A smart house in central London would be out of reach for most private investors, even after the recent price falls. In fact, buyers would in many cases need more cash now than at the peak of the market, such is the shortage of mortgage finance.

But there is another option for investors who want to gain exposure to desirable London postcodes but cannot raise enough money for an individual property: residential property funds.

These pool investors’ money and buy a number of properties that are then let out and managed on behalf of the fund. Providers say that as well as providing easier access to exclusive parts of the property market, these funds enable investors to diversify their risk, so they are not so exposed if tenants default on rents. Investors will also escape the day-to-day chores that beset private landlords.

One example is the D&G Investment Management’s Prime London capital Fund. Launched at the end of 2006, this open-ended fund aims to give access to the prime property market at a much lower cost.

The fund invests in flats and houses across some of the most expensive parts of central London. It owns eight properties in Knightsbridge, Chelsea, Belgravia and South Kensington.

Investors can buy individual units in the fund for £1,000 that give them a share in each of the properties. They have a monthly window in which they can trade.

“The idea is to make this asset class available for people with modest amounts of money,” says Stephen Yorke, manager of the fund.

He believes the fund also attracts investors who want a broader exposure to the property market. In fact, some landlords have recently approached Yorke about exchanging their own properties for units in the fund.

“We have had a few inquiries from landlords looking to swap their flat or house for units in the fund,” he says. “They don’t want to have to worry about managing the property.”

Another advantage of the fund is that it generates capital gains rather than income. It does not pay dividends – the rent received goes towards debt and management costs – so the return to investors is based on growth in the value of the properties.

Another property fund is the London Central Residential (LCR) Recovery Fund. This closed-ended fund – the second to be launched by LCR – is looking to raise £10m to buy discounted property in what it calls the “bullseye” of central London.

The fund is aiming to capture the bottom of the housing market. “We want to exploit the recovery in the market,” says Naomi Heaton, who runs the fund. “We are allowing people to get into the market at attractive levels who may not have the money to buy directly.”

The fund is focused on smaller properties – typically one and two-bedroom flats – worth less than £1m, which it can let to corporate tenants. It is looking to raise £10m, of which £4m has already been secured, and will borrow a further £13m.

The fund aims to run for five to eight years and double the value of the equity.

Both this fund and the D&G fund aim to outperform the broader market by buying properties with short leases or those in need of refurbishment and adding value by improving them.

While these funds have managed to protect investors from the worst of the market falls, investors have lost money.

From February 2007 to March 2009, the value of units in the D&G fund fell by 10 per cent, compared with a broader market fall of 26 per cent, as measured by the Savills Prime Central London index.

LCR’s first fund, which was launched in the property boom of 2007 has fallen by 4 per cent to date. Heaton says enhancing the value of the properties and a fall in borrowing costs has helped protect against sharper falls.

However, house prices are widely expected to fall further. Also, rents have softened in recent months and are likely to continue to do so as demand from corporate tenants falls and supply of rental accommodation increases. Yorke at D&G says a few tenants have tried to negotiate lower rent in recent months.

These funds are based offshore and so fall outside the regulatory protection of the Financial Services Authority. Yorke says this means residential property funds should be the preserve of sophisticated investors who understand the risks.

The other downside is that they are fairly illiquid. Yorke says the D&G fund has so far been able to meet all redemption requests without having to sell any assets. But he says investors should generally be looking to tie their money up for a number of years.

Heaton says there are options for those who want to withdraw their funds early but this may mean investors have to sell their holding at a discount.