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Income: how wealth managers can exploit residential property

Income: how wealth managers can exploit residential property

Wealth Connection Pierre Coussey highlights why residential property should not be overlooked in the hunt for income.

In an exclusive article for Wealth Manager, Coussey writes.

Residential property is the biggest asset class in the UK. Worth more than £4 trillion, it dwarfs listed equities, gilts, corporate bonds and commercial property put together. 

But is it really an asset class in the true sense of the term? This question could equally have applied to commercial property prior to the mid-1990s but that is now considered a mainstream asset class – and rightly so.

Housing has very low correlation with other asset classes. Actuarial consultant Barrie & Hibbert put its correlation with UK equities at 0.10, even with commercial property at 0.35, so it would make a great diversifier for a portfolio, given its long record of inflation-beating returns.

Underlying Castle Trust’s HouSAs is the recognition that housing is not a short-term holding but a fixed-term investment for three, five or 10 years (offering a 3% yield per annum over a 10-year term, paid quarterly) and you get a formula-driven return based on the Halifax House Price Index (HHPI). 

Delivering income

A bit like a tracker fund, you can monitor your investment over its term by keeping an eye on the monthly HHPI. 

If you opt for the income version, you will match the index and receive a predetermined quarterly income over the term. If you select the growth HouSA, you know you will outperform the index, whether it rises or falls, as long as you are prepared to leave your investment with Castle Trust for the full term.

How Castle Trust delivers the returns without actually buying properties is by using the money from HouSAs to lend out as shared equity mortgages, known as partnership mortgages.

Some money is kept aside to cover any mismatch between the mortgages and the HouSAs, for example, if not enough mortgages have been repaid by the time the first HouSAs are due for payout. The plan is for the portfolio of mortgages to match the HHPI, and the returns on the mortgages are intended to ensure Castle Trust’s balance sheet is always strong enough to pay out the maturity values of the HouSAs. 

Meeting losses

Although HouSA investors buy shares or bonds – depending on whether it is a growth or income HouSA – issued by Jersey-listed companies, the companies do nothing other than pay the proceeds and the quarterly income. 

Whether they can pay the proceeds when the time comes depends on Castle Trust being financially strong enough to do so through the returns on its partnership mortgages. 

Because Castle Trust acts as its own counterparty and commits to buy back the shares and bonds on maturity, investment in a HouSA qualifies for coverage by the Financial Services Compensation Scheme (FSCS).

Portfolio assets

The plan is for the mortgages to match the HHPI by distributing partnership mortgages nationally.

The shared equity nature of the mortgages is intended to ensure that Castle Trust’s balance sheet is always strong enough to pay out the maturity values of the HouSAs. According to AKG Actuarial Consultants, Castle Trust is at least twice as well capitalised as any of the high street banks.

Distribution Technology has shown that using a national housing index instead of commercial property would provide a better risk-return profile in all of its portfolios, given the lower volatility and low correlation. 

Coupled with no total expense ratio, there seems to be real merit in adding residential property to clients’ portfolios.

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