What Are the Risks of Real Assets as an Investment?

All investments, including property funds and other real assets, carry risk.

Following years of poor performance by market-traded securities, investors are choosing real assets as an alternative. But all investments are subject to risk.

Battered by an economic downturn over several years, investors in the United Kingdom are, like their counterparts in the European Union and the United States, looking for investments that maximise asset growth. Traditional market-traded securities (stocks and bonds) in particular have underperformed, leading investors to look at alternative investments.

Alternative investments range from the opaque (short only funds, ultra short funds, absolute return funds, market neutral funds, hedge funds) to the transparent, such as real estate investment trusts (REITs), private equity and venture capital. A subset of alternative funds includes real assets, including land, developed real estate, rarities (art, antiques, stamps, fine wine, coins, antique cars), precious metals (gold, silver, platinum, palladium) commodities (energy sector fossil fuels, plus agricultural goods such as wheat and corn) and even renewable energy products (biofuel crops, solar panels and wind turbines).

This last category, real assets, holds great interest after the disappointments of exotic and complicated investments such as derivative assets. Art can be appreciated with the eyes, much like antiques. Fine wine can be held, traded or even consumed (a reckless investment act, but sometimes a celebratory gesture of something of even greater significance). Land can be traversed, formed, beautified and turned into human habitat. Precious metals are sometimes adornment, or held in bulk in safety vaults. We feel good when we invest in energy to power industry, perhaps even more so when it is from renewable and non-polluting sources. An antique car might be driven for very special occasions – carefully and responsibly.

But real assets such as these carry their own risks. While insurable, rarities such as art and antiques can be utterly eliminated by fire, natural disaster or theft. Commodities are subject to market forces that can, under some circumstances, cut value to a net loss.

Land investment and land development are also subject to external forces. But professional advisors control variables in strategic land investments with methods that include the following:

1.    Choose land that will likely appreciate – Experienced land investors (many investors join small-group funds with professional advisors) search for property that is ripe for development (usually for housing) to accommodate the U.K.’s growing population. Such properties are typically slated to become part of a town plan. The investors – who at a minimum invest £10,000 – do not blithely wait for the planning process to play out but actively ensure their land investment progresses on a timely basis.

2.    Infrastructure investment (where appropriate) – Some land investments benefit from the building of roads, the installation of utilities and water and sewage removal. This makes the property ready to build for construction firms.

3.    Expertly time the land sale – All strategic land development follows a pre-set timeline. This is important to the investor, as he or she can know when to expect a distribution on the eventual sale profit.

Still, even well managed property funds investments come with unknown variables. Would-be investors who want to learn more about strategic land should consult with an independent and qualified personal financial advisor.

Understanding Strategic Land Partnerships

The cumulative leverage that multiple investors achieve through strategic land partnerships enables them to make optimal acquisitions.

Strategic land partnerships are essential to most investors who wish to participate in land development but who lack the expertise or capital to do so individually.

What many land investment professionals recognise is that the present opportunity is ripe and rare. Land prices are depressed as a result of the recession, and yet many municipalities are interested in promoting development as the recovery progresses. A partnership of investors, working through a strategic land fund, can pool resources to make optimal acquisitions.

The parcels of land in a strategic acquisition will be situated in an area that is ready for growth. The partnership will process a change-of-use/rezoning designation, increasing the value of the property before it is sold to residential or commercial developers for construction. Real asset growth from such partnerships generally outperforms the alternative, real estate investments trusts (REITs), because these partnerships are less subject to volatile trading prices.

The nature of real estate, where every property is unique, defies typical valuation comparisons that investors try to analyze when, for example, choosing a company stock. This underscores the value of strategic land partnerships in that the managers who work for the partnership bring strong expertise to the enterprise. They know how to identify where opportunities are strongest, including where local conditions are favourable to development – and where they are not. They are able not only to identify the opportunities but also to analyse risk and to plan how to take the land to development-ready status.

Understanding Real Asset Funds

For investors looking to alternatives to the stock market, real asset funds are attractive for diversifying risk in less-volatile investments.

Real assets provide an excellent hedge against inflation and are particularly attractive in times of market volatility, when stocks and bonds are underperforming or erratic. This is because real assets – things such as land (real estate), natural resources (oil, gas and coal), precious metals (gold and silver), commodities (timber, wheat) and equipment – often perform counter to the market. Investors flock to real asset funds when other investments, including publicly traded stocks and bonds, are volatile or depressed.

A real asset fund allows the individual investor certain advantages. He or she can be diversified across one or several real asset categories. That investor is also joining similar investors to own more of one or several assets.

A good illustration of the advantages of real asset funds is land investment (ie, undeveloped real estate). Where an individual investor would want to limit his or her exposure on a single piece of property owned outright (or owned with the help of a loan), an asset fund made up of many investors spreads the risk, often without the need for external financing (ie, bank loans). With a larger pool of money, it becomes possible to purchase larger and more attractive parcels of land. The fund investors are also able to hire better advisors, counsellors and managers to maximise their investment. These professionals typically work within the same group, thereby guaranteeing more focused advice and greater commitment.

Currently, asset fund managers are very actively involved in real estate acquisitions, owing to the exceptionally low valuations on land coming out of the multiyear global recession. Because banks still follow stringent lending criteria, private investors, in the aggregate, in a real asset fund are better able to purchase properties with strong growth potential.

Real Asset Portfolio Investing

Investors who choose real asset portfolio investing appreciate diversification and reduced exposure.

The expertise that an investment advisor can offer means informed investment decisions and reduced risk as well as a range of ownership.

When an investor chooses to participate in a real asset portfolio, he or she is being strategic on at least two fronts. One is that real assets (commodities, precious metals, real estate, etc) are often used as hedges against inflation and market volatility that may be affecting financial instruments such as stocks and bonds. Second, by investing through a portfolio, the investor is avoiding exposure that might come from owning just one or two real assets.

Real estate is historically a smart place to achieve real asset growth – a large proportion of personal wealth has been historically achieved through both developed and undeveloped land. The “lone investor” alternative – owning just one piece of property – subjects that investor to the whims and happenstance of local jurisdictions and local economics. It does the owner of a large tract of land little good if the local jurisdiction is unfavourable to zoning changes or if a depressed regional business environment causes that land to drop in value.

This is where a well-managed real asset portfolio offers a strong advantage. The portfolio will have multiple properties in multiple locations. A portion will be readily realisable, returning value at paced durations. Any exposure to local challenges would be minimal, largely because fund managers are skilled at avoiding problematic assets in the first place. The level of expertise an experienced fund can bring to bear on a land acquisition also reduces the risk of poor investment decisions and low returns.

Understanding Alternative Investment Funds

Real estate land funds are a type of alternative investment that can provide solid and significant returns.

Trading in stocks and bonds is by far the most recognised means of investing. But in fact there are alternative investment funds that serve a key investment role for individuals of high net worth and for corporations and institutional investors.

Alternative investment funds cover a wide range of categories, from managed futures to hedge funds, private equity funds, exchange funds and real estate. Each of these offers opportunities – and risks – for the investor that are not found in traditional investments, stocks and bonds.

Real estate land funds are a type of alternative investment that can take many forms. These include everything from commercial property (industrial warehouses, retail centres, office buildings) to multifamily housing to undeveloped land. Each type of real estate-based investment fund carries its own set of tax implications and growth potential for the investor that can be advantageous. For this reason, these investments need to be evaluated one investor at a time.

To illustrate, a land investment fund can be focused on areas zoned for one purpose or another. The market factors that would favour one such an investment – for instance, land appropriate for new housing construction, at a time when demand for housing is expected to increase – can provide a good return in a few short years. But if that land is unlikely to get a change-of-use zoning from the local authority, the value proposition changes. These and other variables require investors (and investment advisors) to study such alternative investment funds carefully.

When it comes to investing in land, it is wise to focus on the most profitable part of the land development process: acquiring strategic land sites that have been identified to come forward for residential or mixed-use development but do not yet have detailed plans or permissions.  There exist strategic land investment advisors who produce sustainable "development-ready" land sites before selling on to house builders or other development companies.

Choosing Capital Growth Partners

People with deep knowledge about alternative investments (land, hedge funds and so on) are capital growth partners to investors.

The goal of almost all investment is capital growth. This is as true in the publicly traded stock and bond markets as it is in alternative investments (hedge funds, real estate investment trusts, foreign exchanged funds, private equity and the like).

But because most investors are themselves not intimately familiar with the businesses and real assets they invest in, they largely depend on investment advisors to find investments that are well managed. Advisors and managers are, by definition, capital growth partners with investors, as they match funds with appropriate and productive assets. Land investment advisors typically have an expert team in-house, but also it also work with a select group of strategic partners to deliver the best return on its investments.

A capital growth partner in strategic land development provides a good example of how this works. Land is a finite asset, which set against a growing population – in countries and regions where the population or commercial uses of land are increasing – generally means that the land will increase in value. And yet there are many unknowns about individual tracts of land: how is it currently zoned, and what are the chances the parcel or parcels are ripe for development? What other factors, such as new employers entering the area, might drive up demand for property? Are there environmental issues with the land that make it unsuitable or prohibitively costly for development? These are critical questions that a real estate advisor to a capital growth partner should be able to answer.

Capital Growth Properties: A Vital Market Sector

Some land investments qualify as smart capital growth properties. Discerning good from bad is the ultimate goal.

While capital growth is a fundamental and obvious objective of any investor, capital growth properties are an important sector of the market that focuses on real estate.

There is growing interest in capital growth properties for a number of reasons. One is that a worldwide recessionary economy of several years has depressed the price of land almost everywhere. This spells opportunity for many investors. Another is that knowledgeable –or well-advised – land-focused capital growth investors can mine such opportunities that are otherwise overlooked by generalists.

Of note, prospects for a value return may be poor in some locations and countries, but expectations for value increases are justifiably greater in other areas. In the United Kingdom, there is a high demand for land caused by a chronic shortage of housing. The UK government is now committed to a major house-building programme, which will need land to be made available for development.

These factors reflect how land is quite unlike other investments, such as stocks, bonds, foreign exchange funds and hedge funds. The investor who is interested in capital growth properties must necessarily find land investment advisors who are intimately familiar with specific properties and all the variables affecting those properties. Those variables include local zoning, local economies (as they might affect demand for commercial or residential development, for example) and the nature of the land itself.

Capital growth is healthy in some countries but not in others. Investors prefer stable countries and economies with growth potential, including the United Kingdom, the United States, Brazil, certain Mediterranean European nations (France, Portugal and Spain) and several Asian countries (including China).

What are Strategic Land Advisors?

Because investing in real estate requires parcel-by-parcel study, strategic land advisors serve an important function for land investors.

Investing in land under current real estate market conditions is attractive to many individuals and institutional investors. But unlike other investments that allow apples-to-apples comparisons of such things as P/E (price-to-earnings) ratios, multiple variables associated with any property require close familiarity with all parcels.

This work is typically undertaken by strategic land advisors, who put together world-class teams of such professionals who make highly detailed analyses of any opportunity ahead of acquisition.

What the advisors – who generally manage strategic land funds or joint ventures – bring is an expertise in asset growth in real estate. Specifically, strategic land investing requires a skilled selection of property that holds promise for development. Such properties should be situated geographically where growth is likely – through housing or commercial development, in particular. That land also should be ready for change-of-use rezoning, with enthusiastic support of the local governance structure, such that homebuilders or commercial construction firms will find it attractive to purchase. A qualified strategic land advisor should also be able to determine where demand for housing and commercial property exists.

The alternatives for land investors include real estate investment trusts (REITs), which function much like the markets for stocks and bonds. While it enables greater liquidity for the investor, a REIT tends also to be subject to the ups and downs of the markets. Returns from an investment in REITs, consequently, are muted.

Understanding Capital Growth Funds

Funds tied to capital such as land – and not the stock market – are more affected by specific local conditions and benefit from location diversification.

A capital growth fund is any portfolio of investments that is assembled with the intent to generate an investment return. Typically, those returns are reinvested.

Of course, achieving capital growth – to sell at a price that is higher than the price paid on the investment – is a goal, not a guarantee. But the chances of success are much enhanced by working with professional capital growth professionals who truly know the assets that are being invested in. The collection of investments within the fund and the market conditions that affect them determine whether a capital growth fund lives up to its name.

Capital growth funds based in real estate are different from, say, those tied to the stock market. Fund managers look at the distinct and unique combinations of land tracts to maximise certain factors, including local market conditions that would increase or decrease the value of each particular piece of property. A balanced capital growth fund in real estate would also be diverse across many geographical jurisdictions such as counties, as a local political structure can influence how land is used and zoned.

Also, diversification in the likely end use of the land (residential versus commercial, for example) can help the capital growth funds investor hedge against disruptions in any particular sector. The expertise of capital growth fund managers in land acquisition and land planning is therefore essential for developing valuable real estate-based capital growth funds. Experienced fund managers focus on the most profitable part of the land development process: acquiring sites that have been identified to come forward for residential or mixed-use development but do not yet have detailed plans or permissions. Lucent then works with its own in-house team of specialists augmented by a select group of advisors to produce sustainable "development-ready" land sites before selling to house builders or other development companies.

Joint Ventures in Strategic Land

The current state of market-based investing makes strategic land joint ventures the preference among investors who want to avoid volatility.

The contemporary opportunities in strategic land investing are based on several factors. One is that economic conditions have depressed the value of land in recent years. Another is that pent-up demand could well drive an increase in that land valuation over the next several years. A third is that both homebuilders and commercial construction companies are less interested in buying raw properties than in building and marketing those properties after they are made ready for development.

Investors have several choices in how they can participate in real estate on a large scale. One is through real estate investment trusts (REITs), which tend to be subject to market volatility owing, in part, to the liquid nature of the shares. Many investors choose instead to work with managed strategic land investments, through either funds or joint ventures.

In strategic land joint ventures, the defining relationship is between managers with skills and expertise (for identifying properties that will create the best return) and the investors who participate in the enterprise. The managers in the joint venture perform best when they acquire and manage properties that are ripe for a change-of-use rezoning. This creates value by transforming property into ready-to-build status. The significant returns that Lucent has already seen in this area suggest it is both highly profitable and low risk.

Whether the investor chooses a joint venture, a fund or a REIT generally hinges on his or her overall investment and tax strategies. But the strength and track record of the management team in any real property investment should be a key consideration.

Alternative Investments: Minimising Risk in Unknowns

Can the Risks Inherent in Alternative Investments Be Minimised?

The nature of alternative investments such as land makes it difficult to quantify risk. You can overcome the unknowns by understanding the investment opportunity.

The fundamental strategies for investing – minimising risk while maximising returns – are almost universally held and apply to nearly every type of investment. But the uncertain nature of most asset classes in the past few years has radically altered how investors have gone about achieving this. So what is the state of affairs now?

A global survey compiled in 2012 by Towers Watson in conjunction with the Financial Times found that, in general terms, alternative investments are attracting more investment than in the past ("alternative investments" is a term typically applied to managed futures, hedge funds, private equity, exchange funds and real estate). The report attributes a perceived instability in the global financial system, as it affects stocks and bonds, as the reason more assets are being allocated to alternative investments and investment funds.

The leading asset class within the broader category of alternative investments is real estate. According to the report, about 35 % of funds being invested outside stocks and bonds are allocated to real estate, followed by private equity (22%) and hedge funds (21%). Infrastructure and commodities draw about 3% each of the total of about $3 trillion (£1.9 trillion).

The fact that the largest portion of investments is drawn to land suggests that the return will be maximised while risk is minimised. What is it about land that makes this happen? Several factors are in play:

• Natural population increase ultimately leads to land value appreciation. Particularly in the developed world, the matter of supply and demand is the ultimate determining factor. According to the Towers Watson report, “The global economic crisis has spurred the vast majority of investors – both private and institutional – to readdress their asset allocation strategies … [such that they] align their portfolios with basic trends in underlying fundamentals such as population growth and economic expansion in emerging economies.” In countries with a net increase in population from immigration and a high birth rate, that becomes doubly so.

• Land has strategic locations. As industries and local economies shift, so too does the value of land. When a region attracts one or several companies, an employment base and a need for housing will both rise in the vicinity.

• Land use can be managed to reduce risk. When public officials can be shown the value of rezoning an area, this can significantly add to the value of the land therein. Land investment managers with land-planning skills, land development acumen and land site assembly analytical tools are the best equipped for containing land investment risk – and increasing its reward.

All land investment in the UK comes with some risk, but the most strategic land development organisations are satisfying individual and institutional investors who may be unhappy with their more traditional alternatives. For more information, speak with your personal financial consultant.