The diversification of high-end dwellings

A recent survey by property agents Knight Frank revealed that high net-worth individuals plan to increase their portfolio allocations to real estate, but also reduce levels of leverage: it found that the typical ratio was 32 per cent debt to 68 per cent equity, supporting observations that any rise in the cost of capital is likely to affect luxury properties less than other segments. Research from luxury hotel and resort-based real estate investment firm BlueSky Capital also shows that demand for luxury accommodation has shown little or no price sensitivity over the past five years. Average prices and occupancy rates grew by 6.4 per cent and 1.4 per cent per year, respectively. Moreover, premium travel destinations have consistently enjoyed higher occupancy rates compared with their neighbours, which in most cases are also tourism-oriented. These characteristics might suggest that the high-end property market would exhibit some decorrelation from real estate and broader financial markets – which would make it an attractive asset class in an ongoing property bear market and volatile environment for equities and bonds. Although quantitative research to back up these anecdotal and fundamental assumptions about the support underneath the higher end property market is thin on the ground, BlueSky Capital found very low interest rate sensitivity when it looked at the performance of the related luxury hotel real estate sector: over the past 15 years, correlation of quarterly luxury hotel REIT index returns and 30-year US Treasury rates was -0.03, probably because the ability to leverage on solid collaterals such as property is rewarded with better conditions as the general cost of capital increases for all businesses. Luxury wins For the past five years, luxury hotel properties have been outperforming non-luxury by the tune of 21 per cent to 15 per cent compound annualised. But, more notably, since 1998, rolling one-year correlation of luxury hotel assets with the S&P500 has been as low as 0.08 and remained below 0.55, while non-luxury has topped 0.7. That divergence now appears to be increasing as non-luxury becomes more correlated with equities and luxury, perhaps thanks to constraints on size, and remains in the 0.5 range. All of that should provide some comfort to the second home owner who may be thinking of selling up within the next five years or so. But for those who see high-end property purely as an investment asset class – who perhaps want to diversify an existing real estate portfolio, or get the greater decorrelation with equities that luxury property affords – pooled fund products are available. De Rosen Design & Build, a firm focused on designing and building tailor-made luxury villas, occasionally opens up opportunities for investors to participate in new projects, usually in the form of syndicated real estate participations. Last year, it launched a new, BVI-domiciled fund, Global Waterfront, to invest in and develop Mediterranean and Caribbean waterfront residential property, which closed its first subscriptions – available from E500,000 – in July. “There is a diminishing supply of available waterfront property in places such as Cap D’Antibes, Mallorca, St. Barts and Barbados, and the increasing price of these properties will help the fund to achieve greater capital appreciation compared with similar inland properties,” said director Tim de Rosen, during the marketing drive for the product. Pooled funds For those who want to use their investment properties yet remain diversified, a new subsidiary of BlueSky Capital, WPR Management, headed by ex-Coutts & Co senior client partner Mark Jankovich, has launched a pooled fund, distributed by Pure International, that will invest directly in a portfolio of 30 luxury residences in 20 locations, with an average value of £1.35m (E1.8m). Three hundred investors allocating £160,000 will get a share in the portfolio alongside the right to use any of the properties rent-free for five weeks of every year over the 10-year lifetime of the fund. Seventy per cent of the portfolio will be in what Mr Jankovich calls ‘blue chip’ locations – Rome, Portofino, New York, Cape Town, Verbier, Montego Bay and Mont Tremblant, for example – with the rest betting on “slightly off-beat” places such as Croatia. “We can trade the portfolio throughout the life of the fund, and if those hot properties go up by 200 per cent in five years, they’re out,” says Mr Jankovich. “I will write to investors telling them either that we’ve haircut their five weeks in exchange for a big dividend cheque, or that we are going to plough the money into another property.” WPR forecasts an 11.61 per cent compound growth rate for the portfolio, representing a total return of 90.38 per cent and an IRR of 6.65 per cent. But then there is the five weeks’ holiday. With 30 properties split between beach, spa, city, skiing and golfing themes, that equals 150 weeks of choice per year. That insures investors from the 4.1 per cent annual price inflation on the cost of holidays for 10 years, and if you factor the open market value of those holidays – which WPR puts at £160,000 – into the fund’s returns, investors stand to pocket £464,609 at the end of 10 years: that’s a 190 per cent total return, or 11.25 per cent IRR. Of course, if you don’t want to take all five weeks’ (or indeed any) holiday, you can give it to friends or family, or let WPR use it to earn a rack rate via exclusive rental agencies such as Interval International (thereby benefiting from holiday-costs inflation). “It’s a great diversified residential play that’s effectively a free option on global high-end property appreciation over 10 years,” says Mr Jankovich. “Anyone who doesn’t have a buy-to-let portfolio already would find this a great way to get exposure to £1m properties in effectively a buy-to-let environment.” He believes the lifestyle aspect of the fund is the key in today’s private wealth management environment. “We are coining the phrase ‘hybrid investment’ for this,” he says. “It gives you a financial return and a lifestyle element that is going to appeal to top-end private bankers… and sophisticated wealth managers [who] are going to be talking more with clients about lifestyle and how to get a return out of it.” The way of the future Jankovich has “no doubt” that this kind of product is the future of the second home market for his target investors – 30-to-55-year-old heads of young families – and is confident that at the end of 10 years at least 30 of the fund’s 300 investors will opt to buy a property they’ve been staying in, allowing the portfolio to be recycle internally. And if more products such as this do appear, they will add even further valuable liquidity and support to the luxury real estate market. “Even if there is an economic shock, there are still going to be guys who are willing to pay £150,000 in to get £1.5m home,” as Mr Jankovich puts it. “And any shock that knocks people out of owning a second home and into this is great for us.”

Appreciation: available waterfront property in the Caribbean is becoming scarce