Expenses of Purchase and Management

The costs of real estate transactions in the UK are high compared to other asset classes. This is partly due the necessity of establishing a vendor's legal title to a property. Transfer costs of real estate, comprised of solicitors, and surveyors fees and stamp duty, can be as much as 5% of the agreed sale price. In addition, VAT on these fees, as well as that on VAT-registered properties, is payable by investors not exempt from tax. 

Two additional factors which contribute to real estate's relative illiquidity are its indivisibility, and the higher costs associated with its management. As discussed above, the relatively high unit cost of investing in real estate has deterred the participation of smaller institutions, the effect of which is increasingly seen in the direct real estate investment market; see section 2.3.3

Portfolio management may broadly be described as the structuring and restructuring of assets in order to optimise financial returns. Investment needs, and attitudes to markets and/or asset classes, constantly change. A fund manager who cannot adapt a portfolio to meet these exposes that fund to an increased level of risk. Whereas the restructuring of equity or gilt portfolios can only be achieved by trading investments, with real estate a fund manager has several alternative methods at his disposal with which to restructure. These include lease restructuring, development, change of use and/or refurbishment. Notwithstanding the existence of planning and other legislation, a freeholder has considerable discretion as to what can be done with his land. Most importantly, he can let it on a wide variety of arrangements tailored to best suit his particular investment requirements. However active management may benefit real estate, it does so at an increased cost. IPD [1994] estimated the cost of management to be approximately 2.5% p. a. of a property's rental income. Richard Ellis [1990] estimated the cost of managing a real estate portfolio to be 0.4% to 0.45% p. a. of the value, which compares with an equity portfolio of similar size with costs of around 0.25% p.a.33

It can therefore be concluded that although the relative cost of management is an issue, it is not one that should deter large institutional investors. However, real estate portfolios suffer from considerable inertia; that is, they take time to restructure and cannot be bought and sold at will. It follows that the greater the portfolio inertia i.e. the larger the proportion of a portfolio held in real estate, the less management can depend upon short-term tactics to achieve above-average returns. This causes the management of large real estate portfolios to be essentially strategic.


33Richard Ellis's [1990] analysis assumed the portfolio, to be of a value of £100m. Although Richard Ellis and IPD estimate costs on different bases, there would appear to have been a sea-change in the level of costs between 1990 and 1994. This is an example of the quality of information available in the real estate market; see section 2.4.1.