Three Challenges with Real Asset Investments – and How to Work Around Them

Learn how to work around these three primary problems with real asset investments.

Illiquidity, a lack of expertise and the unknown dynamics of the marketplace all affect the growth of real assets. Smart investors know how to minimize their exposure.

Investors have been diversifying their portfolios with greater enthusiasm since the financial crisis of 2008. Given the failings and vulnerability of market-traded securities, they are increasingly adding real assets to their financial planning, finding asset growth in such things as precious metals, art and antiques, raw and developed land and hedge funds.

But real assets are like any class of investment: each has its challenges – which makes sense, because if there were no risk there would be little reward. For any investment to be worthwhile – even if it is daunting to the feint at heart – it must come with some vulnerabilities. The smarter investor can then pick his or her way through those challenges and figure out ways to mitigate risks.

One of the best illustrations of this is land investing. Every property, particularly land tracts that are undeveloped, has a truly unique set of variables while being subject to national economics and even to some extent the global economy. Consider the three primary challenges to land investing – illiquidity, asset knowledge and marketplace dynamics – and some ways that these investment risks can be minimized or even eliminated:

1. Illiquidity – There are two conflicting theoretical arguments about economics. One is that, essentially, everything is for sale, and that every product has a buyer. But in fact, there is friction in all markets that slow things down and prevent buyers and sellers from doing neat, instant transactions. Market-traded securities are perhaps the best examples of very liquid assets, yet trading halts and high bid-ask spreads can slow even those down.
   
   Greater illiquidity happens with real assets such as land, of course. Land investors sometimes anticipate it will take several years for the asset to reach an adequate value increase before attempting to sell it, and then the legal matters relating to the transaction generally takes months to execute. Rare antiques, art, precious metals and other real assets have similar challenges in that the transactions involve certain factors that slow the actual sale of the asset.
2. Asset knowledge – Art dealers make a handsome income for a reason: they understand art and art values. The same can be said about antique cars and other fine collectibles. Each requires deep knowledge of the asset class itself, as well as the current dynamics that affect near- and long-term values.
   
   Using the same example of raw land, knowledge of the investment and all factors affecting it require expertise on the part of the investor. To this point, it should be noted that fraudulent schemes have promoted worthless land to unsuspecting investors. Anyone investing in land should have skills in site evaluation and planning, and be able to gauge municipal planning authorities’ propensity to rezone land for alternative uses (typically, authorizing it for residential or commercial development). The land investment expert will also be able to judge how much time will be required to turn raw land into something of greater value – enabling investors to understand how long they must wait to see a return on their investments.
3. Dynamics affecting value – To see where world events can affect the price of a real asset look no further than what has happened lately to the price of gold. Between October 2012 and February 2013, prices tumbled from a high of $1800 (USD) per ounce to $1600 per ounce – after a 481 percent increase from 2002, when it traded for about $275 per ounce, the biggest gains coming after the 2008 global financial crisis.
   
   Historically, gold prices have mirrored the ups and downs of interest rates, but other factors have played a role in the stratospheric increase of gold in the past decade. These include a slowing global economy, sovereign debt problems worldwide and the downgrade of U.S. debt, as well as fears tied to deficit spending by governments.
   
   Land investment in the UK is currently driven by a distinct housing shortage. While it remains difficult for many young people to get adequate financing, that may ease in the near future. Also, more housing may be built for the rental market, which has grown considerably in recent years. The dynamic is a continuing population growth rate in England and Wales (7 percent in the decade preceding the 2011 census) juxtaposed against a woefully inadequate amount of building to replenish the housing stock. Also, the economics of one town may differ greatly from another, with pockets of growth tied to the fortunes of one or two industries.

The trick is to predict with confidence what the dynamics will be and how it might affect real asset investments. E.g., with built property, commercial and residential, it’s vacancy rates. With undeveloped property, it’s the demand for housing and the political inclination toward encouraging the development of land.

With each of these problems, the seasoned investor – or their investment advisors – will fare best when they apply deep knowledge to the specific type of asset. And just as no two assets are exactly alike, so too are the objectives and portfolios of one investor to the next.

When Buildings are Better than Open Land

The need for UK housing is challenging the greenbelts and rural lands.

Britain’s natural beauty is indeed one of its greatest assets. But a critical need for housing is forcing a discussion on the sacrosanct nature of open lands.

A primary point of debate around the UK’s critical housing shortage is whether or not to build on greenbelts and the open countryside beyond, typically agricultural and forested areas. The argument often boils down to a two-dimensional, either/or choice between increasing density in towns versus building outside the metropolitan areas, accepting a certain degree of American-style sprawl that loses forever some of the best characteristics of the country.

But in truth, the choices need not be quite so distinct. Neither side of this argument has to count themselves winners or losers, as more hybrid approaches can be considered – and in fact are already being implemented on a limited scale. This is not just wishful thinking. Research indicates that there are many choices that allow for different means of expanding land availability to the single goal of increasing the supply of housing.

Considering how investors in the development of strategic land have land investment funds ready to go to work, this is a topic that needs creative thinking. The housing need is great, and developers and homebuilders are also raring to go.   The question is, where can they build?

The greenbelt concept, first implemented in the 1930s, was remarkably prescient in what it sought to achieve. While other countries (in particular the United States) were expanding their metropolitan regions far from core cities – allowing automobiles to become the primary means of individual transport, enabling middle class workers to have larger homes and gardens while they commuted to downtown employment – cities such as London, Cambridge, Nottingham, Bristol, Dorset, West Midlands, and on the Continent (Germany in particular), preserved their dense and compact downtowns with designated greenbelts.

The vision of what greenbelts should be is a region of land enveloping the cities that democratically provide recreation and fresh air to the populace. For the most part, that is what was created. The more densely populated cities of the UK keep people closer to workplaces, stores and community amenities, much of it accessible by foot, public transport or bicycle. Conversely, those sprawling suburbs in the States mean that workers spend onerous stretches of time in traffic, traversing 8-lanes-wide of asphalt from one suburb to the next, leaving little time to enjoy those larger houses and gardens.

The British have a distinct love for greenbelts and in fact have added about 25,000 hectares to the 14 greenbelts in the country since 1997. Local authorities have further plans to increase various greenbelt lands by 12,000 hectares in the future.

But while greenbelts have largely succeeded in their initial goals, they face increasing scrutiny largely because of the housing shortage. The policy is attacked for being too rigid. Also, greenbelts don’t always achieve the intended goals of preserving environmental quality as they are poorly managed in some locales. Among those who criticise the current configuration of greenbelts are the Town and Country Planning Association (TCPA), which decades ago had championed their existence. Since 2002, the TCPA has suggested the greenbelts instead be broken into wedges, gaps and corridors, largely in response to the housing needs.

Baroness Hanham, communities minister in the House of Lords, is critical of absolute policies that protect greenbelts as sacrosanct. She is quoted as advocating for more rural development, so people “can live in the villages in which they were born,” as well as for social housing because some of the land is “not absolutely brilliant” and therefore would be put to better use as sorely needed housing.

For example, an abandoned powerhouse in Formby (Borough of Sefton, Merseyside) sits in greenbelt land. A draw to vandals, it is regarded as an eyesore yet a proposed 62-home development (10 per cent dedicated to affordable housing) is encountering resistance from a community group. The development would require some additional use of greenbelt land, but would also put derelict land into productive use. Should the old building continue to stand and deteriorate, or would it be better to build sensibly and add community infrastructure improvements along with it?

Of note, development of any housing on raw, open lands need not favour social housing over more expensive private homes – or vice versa. The Joseph Rowntree Foundation (JRF), which advocates for affordable housing, looked at eleven countries that are similar to England in how they approach land supply, including restrictions on sprawl and protection of agricultural land. The Foundation concludes that a more sophisticated, layered approach to growth management, “rather than urban containment,” should be considered.

JRF also argues for proactive planning, such as compulsory purchase, because the current housing approach is often incoherent. As an advocate for social and affordable housing, the organization also champions land auctions and land assembly as a means to effect sound development.

Private and institutional investors increasingly are interested in building new housing, both to buy and to-let, wherever such development fits into town growth strategies. Strategic land advisors who engage real asset funds to build are typically cognizant of those town strategies. Clearly, the questions around greenbelts and raw land have to be answered in many areas where development is needed.

With investors ready to build, such conversations and decisions are being pushed forward, making these kinds of debates more likely in the future as more capital is freed up to build much-needed homes. Individuals who invest in development that requires planning permission should consider whether strong opposition exists in that planning authority; they should also discuss such investments with an independent financial advisor who can determine if the risks and rewards of property development fit the portfolio of the investor.

Lucent Strategic Land Fund – Liquidity Position

In light of the difficulties recently experienced by several funds that have led to their suspension or closure I wanted to reiterate the robust controls that the Lucent Strategic Land Fund (LSLF) has in place to ensure its continued financial well-being, particularly with regard to fund liquidity.

Admittedly real asset funds do not have the same liquidity as a daily traded equity fund. This is something that investors should always bear in mind. Liquidity therefore has to be carefully managed. This is an area the Investment Advisors and the Fund have to plan for, both during the initial submission of the file to the regulator and on an on-going basis.

The LSLF fund is domiciled in Luxembourg and is regulated by that country’s financial services authority, the Commission de Surveillance du Secteur Financier (CSSF).

LSLF’s Directors take the management of the Fund’s liquidity very seriously indeed. LSLF has the capability to call on a 30% liquidity margin. This is a significantly higher margin than property funds typically have. A minimum of 10% of the Net Asset Value (NAV) of the fund is always maintained in cash.  In addition, the Fund can facilitate access of up to 20% of the NAV in order to meet, if needed, exaggerated redemptions.  It is able to do this because the LSLF does not use leveraging for asset acquisition.  For clarity, the Fund does not use bank debt to finance acquisitions.

An important competitive advantage the LSLF has over and above other types of property funds is the divisibility of land.  This, together with the fact the Fund’s land assets are not leveraged means that the LSLF can, if need be, sell off part of a site. Indeed larger projects such as the Lincolnshire Lakes project are capable of, and planned to be, multi exit deals with the phased delivery of the asset to national housebuilders and commercial participants. This provides the Fund with, in effect, a ‘rolling liquidity’.

Furthermore, the above phased sale capability, in conjunction with the lack of leverage, gives a competitive advantage over commercial property funds.  Whilst the LSLF can sell off part of a site, a property fund, that has leverage on a 30-story office block, may find it difficult to sell, say, 15 floors.

All of the above make the LSLF’s liquidity position a robust one.

Liquidity is recognised as an extremely important issue by the Directors of the LSLF and is managed in a manner that has been found to be satisfactory to the institutions with whom we deal.

~ Chris Westerman, Lucent Group UK

The Role of Property Fund Managers

Good property fund management bolsters the strength of real estate investments.

The attraction of historically low land valuation is compelling investors to consider real property as an important complement or even lynchpin of their financial strategies. Because most people lack deep familiarity with real estate and land investing and how to discern a smart acquisition from a poor one, investors depend on property fund managers to guide them in their investment choices.

Managers of property funds will follow a strategy, such as a focus on warehouses, retail centres, hotels and resort properties or undeveloped land. Typically, fund managers expect most of the land it acquires to be sold to developers involved in house building.

These strategies adapt to evolving market conditions, of course. A good example of a fund management strategy is one that considers how residential homebuilders are decoupling their role of cost-effective housing delivery from that of land acquisition. That presents opportunities for property fund managers to prepare and deliver land that is ready for construction. The specialists who manage those funds are experts in the acquisition, design, master planning and promotion of sites.

In that same example, it is beholden on the property fund management firm to first identify – on behalf of investors – where the best opportunities lie in land acquisition. They are attentive to where population and economic conditions will drive housing or other needs for land development and to where local authorities are likely to allow rezoning or change-of-use plans to accommodate the kind of development that will ultimately be profitable to all stakeholders.

Can Investors in Property Funds Participate at Varying Levels?

Discover the different levels of participation in property fund investments.

The range across which investors can grow assets includes REITs, joint land investments and sole ownership of vast tracts. Each offers advantages and disadvantages.

Building wealth through buying, selling and holding land is a time-honoured tradition across the world and throughout history, in the U.K. as anywhere else. It is not fool proof, of course – everyone and anyone could get rich if it were – but at least the means by which one can invest in land are now more varied than ever before. It is possible to own shares in a real estate investment trust (REIT) for a few hundred pounds, just as the land barons of today own thousands of hectares in Britain and elsewhere.

REITs’ rules in the U.K. have been in effect since 2007, and are lauded for providing investors a means to access property value increases without having to buy the property itself.

However, REITs are traded publicly and tend to rise and fall with general market trends. The owner of REIT shares has no involvement in the actual properties, therefore value growth is entirely a function of the markets and the broader economy. Performance by REITs shares in the economic downturn since 2008 has been unkind to shareholders.

At the opposite end of the UK land investment spectrum, confident and experienced land developers look for raw, undeveloped land for asset growth. The savviest investor learns where market pressures for developed properties (e.g. housing) drive a need for zoning changes that will convert unused (sometimes agricultural) property to residential tracts. That investor will know how to buy at a price that will ultimately return a profit. The Duke of Westminster, one of the richest land investors in the UK, exemplifies this model.

In between REIT shareholders and His Grace are land development investors who work with property funds that hire professional land investment advisors. The price of entry into either type of fund ranges between £10,000 and £25,000 (US$15,000-$40,000) in most scenarios. Such an investment provides the investor greater opportunities than they might find in an REIT – for example, the prospectus will detail the specific features and risks associated with a particular land purchase. The investor will enter with some knowledge as to how long the investment will be held – typically between 18 months and five years – and what the benchmarks are for light development (infrastructure, less so buildings) before selling to housing or commercial structure developers.

Alternatives to land investing and property funds include stocks, bonds, commodities, hedge funds, precious metals (gold, silver), forestry products, energy (fossil fuels and renewables), and rarities such as art and antiques. For more information on choosing the right investments to match your individual asset growth needs, seek counsel from a qualified financial advisor.

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.