WHILE location may still be the most important phrase in the property investor's lexicon, for more than a decade another "l" word has been challenging for top position liquidity.
With institutions, particularly pension funds, much more concerned about access to ready cash to meet liabilities, the perceived illiquidity of property has become a strong disincentive to invest in the sector.
Buildings are difficult to buy and sell at the best of times, particularly during a recession. Buying property is very different from the quick transactions available in equities and gilts. Exacerbating the problem, property has turned in a consistently poor performance for most of the past 15 years relative to equities and bonds.
Combined with the fact that more liquid alternatives such as property shares carry tax penalties for pension funds, that has led to property falling from over 20 per cent of institutional portfolios to about 5 to 6 per cent.
Ian Mason, a director of the property division of fund manager Mercury Asset Management, believes the real weighting, excluding the largest funds, is probably closer to 2 to 3 per cent.
He was speaking at a conference on liquidity organised by Nabarro Nathanson, the lawyers, last week.
But he also pointed out that there were widespread signs of renewed interest from the sector. The key is finding the holy grail to entice investors back into property: a liquid, tax-transparent vehicle.
"There has been potential for the location of these type of instruments in previous cycles," says John Stephens, a partner at Jones Lang Wootton, the property consultants, "but the obstacles have always been tax transparency and the dilution of liquidity."
Unlike the searchers for the mythical grail, however, modern day property knights know exactly what they are looking for: an equivalent of the highly successful US Real Estate Investment Trusts (Reits). After an extraordinarily successful decade, these are now worth some $90bn (£55.2 billion sterling).
At best, proponents argue, such vehicles would not only entice institutions back to the market but also attract a wave of new foreign money, particularly from us investors who have been historically cautious about dabbling in the UK property sector.
Some optimistic analysts even suggest property should be compared with the US junk bond market in the pre-Michael Milken era: a large, illiquid market with the potential to transform itself into an investors' favourite.
In spite of a series of attempts over the years, all attempts have floundered in the face of Treasury fears about lost income. While representations by the industry to the previous government last year met some sympathy, they did not lead to concrete results and there is little indication that Labour is likely to act any differently.
That in turn has re-focused attention on alternatives that mimic the benefits of Reits. According to David Sproul, a consultant at Arthur Andersen the main difference is that, unlike previous attempts, the calls are being led by the pension industry rather than property owners.
"Previously the push for new, more liquid property assets came from investment banks and advisers, and never quite got off the ground," he says. "But now the process is much more demand driven.
Arthur Andersen carried out a recent survey to gauge interest in the property market. The survey of 20 of the largest funds - those with assets of £1 billion or more - which currently have approximately 8.5 per cent of their portfolios in property investments, showed there was substantial appetite for new property securities.
The research found demand was driven by several factors. For several smaller funds, in the £300 million to £400 million range, the key drive is asset diversification. For example, those with hefty exposure to retail would like an easy way of increasing exposure to industrial and office property without having to buy buildings.
Bigger funds see growth potential in property exposure without having to manage assets themselves. "The message is no longer that the institutions want more liquid property investments, but that they need them," Mr Sproul says.
A number of such investments are already available, including limited partnerships and offshore companies, which are close-ended and tax transparent but may be unacceptable for some UK investors. More recently, a range of synthetic structures based on index-related returns rather than ownership of property have been introduced, with new ones being proposed. These have met some success, but as specialist vehicles their attraction to investors is primarily as a hedging tool. It is too early to tell how broad their appeal will prove.
There was hope that authorised property unit trusts, introduced in 1991 and offering superior tax efficiency to quoted property companies, would provide the solution. Although recent interest has boosted the market, the total invested in such funds is still only about £300 million.
One prominent - and promising - venture that could partially assuage such concerns is the £250 million joint venture being set up by Dusco and Hermes, the fund managers. It takes advantage of changes to stock exchange rules last year and aims to create a listed vehicle with substantial tax advantages over property companies.
Critics warn that ultimately the venture is still vulnerable to the risks of all open-ended funds a run on shares would ultimately force sales of illiquid underlying property assets. But stock exchange rules require the fund to have a substantial liquidity reserve. And Dusco is promising that the scheme - due to be listed this summer - will contain further devices to minimise illiquidity.
Until a Reit equivalent is approved by the government, there is widespread market belief that this is the most promising route available to reversing the decline in institutional interest. As Mercury's Mr Mason admits: "It's not ideal, but for the sake of the property market we have to hope they are successful - and perhaps more important, that they are seen not to fail."
