Forms of Indirect Investing - Case Study Example

Tittle] Indirect Investing Introduction Indirect investment is considered to be the way of investing in the real estate industry without actually making an investment in the property. There are several ways of investing indirectly in assets like funds, private equity and securities. The investors who seem to be interested in indirect investment usually do it by the help of an advisor or a company having expertise in this particular area. The indirect property investment occurs when the investor invests in a product which further invests in any property. This indicates that the investors are not directly investing in the property. Such investment points towards the fact that the investors are investing in a product whose performance to a certain extent is linked with the performance of the property. The example of indirect investing is purchasing units in the property funds, purchasing shares in any of the property company that is publicly quoted and contributing to any pension plant that has a property in its portfolio (Indirect Property Investments). Different Forms of Indirect Investment Indirect investment means investing in the property without actually buying it. The several forms of indirect investment are mentioned below: Real Estate Investment Trusts (REITS): These are considered to be the public property companies that are primarily listed on Stock Exchange. The investors buy shares in these companies that may be traded through the investor’s stock broker. The examples of such public companies are Great Portland Estate, Land Securities and Derwent London plc. The Land Securities is one of UK’s largest property companies that invest in almost all the classes and types of properties present across the country. However on the other hand Derwent London plc only invests in property present in Central London and that too mostly in offices. Unit Trusts: There are several other means of indirectly investing in property. These means may take several other forms that are suited for a number of investors. Some examples of unit trusts are mentioned below: Authorized Investment Trusts: These are the funds that are sold to the general public. Unauthorized Investment Trusts: These are the private trusts that cannot be purchased by general public. The authorized and unauthorized investment funds can be further divided into open and close ended funds. The open ended funds are the ones which do not have a definite life span, which means that they may go on forever and their units can be traded in the open market. The example of Open ended funds is Standard Life Property Income Unit Trust. The close ended funds may have a definite life span, for instance 10 years. After this duration the property is sold and the unit holders are paid out. The example of Close Ended Funds is Schroders WELput Unit Trust. The investment in office property present in London will come to an end in the year 2023, after selling the whole property and paying out the investors. The close ended funds are non-tradable, which means that the investor is not allowed to sell its unit till the trust ends. Many of these Units Trusts are exempted from tax, as they do not have to pay pension funds and tax. SWAPS or Derivatives: They may seem like a difficult concept to understand; however their understanding is significant for analyzing the performance of the property index. They are only available for some sophisticated investors like pension funds and large institutions. They are considered to be the form of gaining the returns through property investment without directly investing in the property but betting effectively against the IPD index. The investor is not actually investing directly or indirectly in any kind of property but is only analyzing the performance of the market (Indirect Investment). Advantages of Indirect Investment There are several advantages of investing in the discussed indirect investments. One of the major reasons is that these investments provide diversity to the investors, decreasing the risk associated with investment. These investments enable the investors to invest in large number of property which they would have been unable to afford otherwise; therefore the investors ends up buying shares in order to gain exposure in the whole market. Suppose that the investor wants to invest in central London but because of the property being expensive and large size of the lot, the investor may only be able to invest in Derwent, a share which is the best option for him. The investor may also invest in WELput Unit Trust in order to gain some more exposure in the offices present in Central London. Most of the indirect investments besides close ended trusts enable the investors to trade the shares/units, in order to quickly enter or exit any market. However on the other hand the direct property may take much longer to trade. In addition to this the buying and selling cost associated with indirect investment is less than that in direct investment. Indirect investment enables the investor to benefit from the performance of the property without the disturbance of actually owning the property yourself. Indirect investments are investments with low capital expenditure and do not involve the risk and trouble associated with refinancing, real estate management, facility management and end users. They help the investors to generate an income stream from the investments. The performance of the property, the investor has indirectly invested in is monitored not just by other investors but also by the media and analysts; therefore the chances of fraud is quite low. The indirect investments come with a return option and the investors are also protected through different investment rules and supervision. There is also the property bond option available in indirect investment. The market also gives the option to the investors for trading the shares present in their property fund. Such investments provide the investors with the option of efficiently capitalizing with the advantage of global diversification. It also helps the investors to achieve a perfectly diversified portfolio with a prominently lower capital outlay. The investors may also rely on the expertise of the analysts for the management of their external portfolio (Direct vs indirect property investing). Case Study This case study discusses different examples of indirect investment portfolio. There is no hard and fast rule for how the portfolio of the investor must be divided, however it is dependent on the investor that how well he research the market before investing in shares. Case of Kay, 59, Approaching Towards Retirement Kay, who is a divorced medical technician, is all on her own. When she retires she will be dependent on return that gets from the indirect investment; therefore she cannot take much risk associated with her indirect investment. Kay’s health portfolio is worth $875,000 that can be divided into half between fixed income and equities. Kay must first think of investing four to five month of her income in money market or in short-term bond funds. This would leave her with $418,000 to invest in some other higher yielding instruments. A better option for Kay is to design a bond portfolio that would mature when she is in her mid-60s, keeping in mind that the interest rates of that time are favorable for her. She will need a bond portfolio that will help to generate an income stream for her in the coming 4-5 years, providing her with cash to pay her bills at the time of retirement. Kay should take about one-third of her bond money and purchase in Treasury Inflation-Protected Securities (TIPS) or in individual TIPS by the help of Treasury Direct, as these bonds will give a modest return on her investment, adjusting the principal amount twice a year based on the existing inflation rates. If the rate of inflation increases in the coming years, Kay would still have some protection on her fixed income which is kept apart from her indirect investment portfolio, however inflation may have adverse effect on stocks. Kay may devote the other two-third of her bond portfolio to the short term treasuries, intermediate-term corporate bonds, high yield bonds, international bonds and long-term corporate bonds. Case of Juan, 29, Trying To Build Up His Savings Juan’s 401(k) shows the current balance of $3,700 but he is seen making a good salary every month. It is important for Juan to save up enough, so that he may have enough money to pay for his expenses of the coming three to four months. Keeping in mind that the 401(k) money of Juan would not be touched until the time of his retirement, he has decided to make the investment of 20 percent of the amount from retirement funds to bonds. The purpose of designing a diverse portfolio for Juan is to smoothen out his returns on investments and provide him with an opportunity of rebalancing his investment in case of any economic apocalypse. If the plans of Juan’s employer are more like his own, then he will certainly have an additional option of corporate bond fund and mixed maturity treasury funds. However whichever way is selected by him would not make any difference in the coming years. If by any chance Juan plans to leave his job, he has an option of transferring his 401(k) to his new job. He also has the option of rolling this amount into his own individual retirement plan (IRA). IRA is known for offering better investment choices and that also at a lower cost. The best indirect investment option for Juan is that he must try to diversify his portfolio by investing in different binds. Case of Jean and Raymond, 61 and 63 respectively Both Jean and Raymond have solid portfolio of indirect investment valued slightly over $750,000. Both of them have secure jobs and at the time of their retirement, their social security fund and pension would be enough to cover their basic bills. Jean and Raymond recently decided to invest two-third of their savings in equities like stocks and some other commodities. Both of them chose to invest their savings in fixed income. This financially fit couple still has an option of using an emergency kitty, as both of them are above 59; therefore they are allowed to use their retirement account without any penalty. They decided to invest 2 percent of their saving in short term bonds, so that they may be able to pay their living expenses in time of need. The rest of the 30 percent was invested in intermediate-term Treasuries, in individual bonds. Another 30 percent was invested by them in corporate bonds. The couple took this decision as they thought that this 30 percent will give them much greater return than government bonds if the economic condition remains stable. 30 percent of the investment was made in the Treasury Inflation-Protection Securities by Jean and Raymond; while the remaining 8 percent was allocated to the foreign bond fund. Marian, 53, Way Behind Her Investment Goals Marian has savings of $75,000 and also has a good majority in stocks. Marian’s 25 percent in bonds which is $18,750 must serve for two important purposes. Firstly, it must provide balance to her annual return of her investments. Secondly, it must be able to provide a stream of cash flow when Marian will retire, so that she may be able to fulfill her dreams like travelling the world. Marian is currently making decent salary by working as a computer consultant. She makes $160,000 a year but living in New York comes with high taxes and other bills. She rents her apartment; therefore she did not get any mortgage reduction. Most of her savings go to the taxable brokerage account. Keeping in mind Marian’s high tax bracket, it will be the best option for her to keep her bonds in the taxable account away from her high quality municipal bonds. These bonds would offer Marian an exemption from local as well as federal tax and would prove to be the best option for her. However due to diversification Marian will have both local as well as national municipal bonds. With having less than $20,000 to be invested in the municipal bonds, Marian would be able to create a diverse and profitable income stream for her future. Conclusion Indirect investment is an ideal option for the capital investors who desire to invest in assets yielding long-term returns with low volatility and stable value. It is a better option for the people planning their retirement or the ones who do not have enough funds to invest in expensive properties. The case study presented above will help in the better understanding about the indirect investment in practical life. Indirect investment has proved to be effective than direct investment in several aspects. Owning a property and dealing with the tenants can be a problem and it may require a lot of time of the owner, whereas on the other hand when the person invests in shares, the investor does not have to deal with all the additional problems. The benefits associated with indirect investment are that on can take advice from their broker and other investors. When an investors is investing in a stock he may not be the only one whose money is at stake, there are several other people who have invested in that stock as well; therefore the chances of fraud and failure are very low. In indirect investment the investor also has the option to minimize the risk by diversifying the portfolio, whereas in direct investment the individual has all his saving invested in a single place which has high risk associated with it. Work Cited Direct vs indirect property investing. 2012. 13 December 2014 . Indirect Investment. 2013. 13 December 2014 . Indirect Property Investments. 2013. 13 December 2014 . Read More