ARC TIME Freehold Income. Too good to be true?

aroominyork

This property fund has grown 85% since launch eight years ago with barely any volatility. Here is the factsheet. Can someone explain what the catch is?

maxsteam

It's not a mainstream property fund. They trade the freeholds for leasehold properties. There's talk about making it easier for leaseholders to obtain the freehold and limiting ground rent increases. A change in legislation could change the value of the fund radically.

85% in 8 years is equivalent to 8% per year.

I looked but I couldn't find it on a couple of platforms. The chunky shape of the chart suggests to me that it may be thinly traded.

lozzy1965

Yes.  8% a year isn't too good to be true.  If someone guarantees that then I would ask questions, but it is perfectly possible to get that from various investments.

maxsteam

I think that the blip near the end of the chart relates to recent legislation relating to ground rent increases. You can check the dates of announcements and votes in parliament if you are interested. I believe that the final draft of the legislation will only be applied to limit ground rent increases on future sales of new build properties so will not effect the existing holdings in this fund. There will be more debates and more legislation on this issue in the future.

dunstonh

One dealing point a month and higher suspension risk.

aroominyork

dunstonh said:

One dealing point a month and higher suspension risk.

Does it have a higher suspension risk compared to other open ended property funds?

Its steady returns are unlike anything I have seen in other property funds - or have I not been looking in the right places?

dunstonh

Does it have a higher suspension risk compared to other open ended property funds?

No higher or less risk. 

Its steady returns are unlike anything I have seen in other property funds - or have I not been looking in the right places?

There are not many like this but it has been on my radar for some years as it passed our research company's due diligence for some years before being removed about a year ago (only because of the open-ended fund structure and the FCA review).  The single dealing date didn't help but ironically, that is probably one of the major reasons it hasn't suffered volatility seen in others.   If you look back to the days before all property funds suffered high volumes of trade, they are similar in terms of volaitilty to what you see with this fund.    

Finding it available on your platform is also difficult.  It has limited distribution.

maxsteam

aroominyork said:

Its steady returns are unlike anything I have seen in other property funds - or have I not been looking in the right places?

It is not just another property fund though. A normal property fund might buy flats on leases, or freehold houses and office blocks, then rent the properties to tenants. This fund buys the freeholds for flats then charges ground rent to the leaseholders. There is a very minimal risk of non-payment or vacant periods. The risk comes from the possibility of legislation that effects ground rent rules. There's been a lot of debate and publicity surrounding the recent trend towards putting clauses into leases which allow the ground rent to be increased significantly over time. Historically, before the recent legislations, the ground rent was usually a nominal sum and the value of the freehold lay in the right to take possession of the property at the end of the lease.

If there is no further change in legislation, the income and capital for the fund is extremely predictable.

aroominyork

I’ve never bought a property fund – or tried to understand the sector – so this is interesting. If I understand correctly, a regular property fund buys a property (leasehold or freehold) and generates income from the rental, and capital gain from increases in the asset’s value. Most such funds buy commercial property. So the risks lie mostly in vacancy periods or property prices falls which affects the underlying value of their assets. If they are OEICs they have to sell properties if there is a flood of ‘sell’ orders, which can lead to gated funds; the FCA is considering mandating longer periods of time to meet redemption requests. REIT’s do not face the redemption/gating problem but since they are ITs premiums/discounts come into play.

This fund does not buy the property itself but buys the freehold and generates income from ground rents obtained from the leaseholders. They are mostly residential so less likely to be vacant. The fund aims to “acquire freehold ground rents which offer a consistent income stream and capital growth prospects”. Presumably any capital growth would be from rises in freehold values on resale to reflect rises in the property market. That seems consistent with the factsheet saying “The Fund’s income return is expected to deliver in excess of 4% per annum. In the current market, where interest rates and bond yields are at historic lows, and even equities that have traditionally paid dividends have seen these reduced or stopped altogether, we believe that the Fund can continue to offer reliable income returns and the prospect of an element of capital return.”

maxstream, you say “Historically, before the recent legislations, the ground rent was usually a nominal sum and the value of the freehold lay in the right to take possession of the property at the end of the lease.” Question 1: Would the nominal ground rent have been sufficient to provide the 4% income this fund was generating? Question 2: Was part of the fund's strategy to take, or seek to take, possession at the end of a lease – it doesn’t seem do to me? Question 3: Um, which legislation?

It seems to me the fund is less prone to redemption requests than ‘regular’ property funds – is that fair? The liquidity strategies in the fund’s Q&A seem robust. However you have to assume there will be a 5% sale charge, either through the Large Deal Provision (>£50k redemptions) or if you are selling less but “if an investor seeks to redeem an investment that would not be deemed large (i.e. under £50,000) through a platform that is also redeeming other investors at the same time, but together they amount to more than £50,000, the Fund will only see one aggregated large redemption and all underlying investors redeeming through the platform that day will be impacted by the large deal provision.”

In summary, this is a relatively low risk way to achieve c.4% income and possible small capital gains through a specialist type of property fund, which can be expected not to be affected – at least not as severely – by downturns in the property market. However, you have to expect a 5% redemption charge, and be aware that returns might be negatively affected by possible legislation in the coming years to make (quoting from the factsheet) “enfranchisement and extensions of leases quicker, easier and cheaper, saving leaseholders of houses and flats money, whilst ensuring sufficient compensation is paid to landlords to reflect their legitimate property interests.”

wmb194

In case you're not aware, there's also a ground rents investment trust, Ground Rents Income Fund plc. I'm not sure how its strategy directly compares to the fund we're talking about but its five year performance, to put it mildly, doesn't look nearly as good. Its company page might have some commentary on the subject of the future.

In December it stated that it's NAV is 103.1p whilst today it's trading for around 71p.

LSE quote, GRIO:
https://www.londonstockexchange.com/stock/GRIO/ground-rents-income-fund-plc/company-page

Company website, it's managed by Schroders:

https://www.schroders.com/en/uk/private-investor/fund-centre/funds-in-focus/investment-trusts/schroders-investment-trusts/ground-rents-income-fund/

aroominyork

maxsteam said:

aroominyork said:

Its steady returns are unlike anything I have seen in other property funds - or have I not been looking in the right places?

Historically, before the recent legislations, the ground rent was usually a nominal sum and the value of the freehold lay in the right to take possession of the property at the end of the lease.

On a bit more research, this site says "Modern ground rents are 0.1% of the property value per year (£150,000 property would be £150 per annum) however there are still a number of properties which have £250 ground rent as standard." So how is the fund, which was launched by 1993, be generating 4%? Have the recent legislations you mention (what legislations, exactly?) seen ground rents increase from 0.1% to 4%?

The fund’s factsheet doesn’t help. It says “Our properties generate consistent, long-term cash flows. This is achieved through long tenancies with an over-collateralised ground-rent structure.” Over-collateralisation simply refers to “the small monetary amount of ground rent, especially in relation to the value of the flat”.