Fears grow of property fund bubble

Commercial property values are up over the past six and 12 months respectively. Picture: Ian Rutherford
Commercial property values are up over the past six and 12 months respectively. Picture: Ian Rutherford
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EXPERTS warn of ‘rose-tinted’ view as high yields prompt investor stampede, writes Jeff Salway

Savers and investors are piling into property funds in numbers not seen since before the financial crisis, fuelling fears that the market could overheat.

Property was the single most popular asset class in September, according to new figures from the Investment Management Association (IMA), with net sales of £315 million. It is the first time property has topped the IMA’s sales table since March 2007, at the height of the commercial property boom.

That came to an abrupt end in 2008, when prices plunged by more than 40 per cent and a liquidity crisis left hundreds of thousands of investors trapped in funds that barred them from withdrawing their capital.

The sector has reached a post-crisis high in 2014, however. Commercial property values are up 10 and 19.7 per cent over the past six and 12 months respectively, the most recent IPD UK Monthly Property Index shows, following a 10.7 per cent rise in 2013.

Aviva has forecast double-digit returns for both 2014 and 2015, while M&G has predicted growth of more than 20 per cent this year.

But with longer-term returns averaging between 6 and 8 per cent, there’s a danger of investors developing unrealistic expectations, said Aberdeen-based Barry O’Neill, investment director at Carbon Financial Partners.

“The clamour to access commercial property suggests a rose-tinted view of the asset class and displays all the classic hallmarks of herd mentality,” he warned. “The reality is that it is like any other asset class – it goes down in value as well as up.”

One of the chief risks to investors is liquidity. When prices plummeted in 2008, firms including Aegon, Scottish Widows and Standard Life were forced to impose a freeze on withdrawals from their property funds to ensure they didn’t have to sell properties to meet redemptions.

Laith Khalaf, senior analyst at Hargreaves Lansdown, said: “Clearly this was precipitated by the global financial crisis and there is no suggestion we are going there again, but property fund investors do need to recognise they may have to wait to get their money in the event of an exodus from the sector, given how illiquid property is.”

Those withdrawal restrictions were later lifted, but open-ended funds (such as unit trusts) reserve the right to block withdrawals if they fear a surge to the exit doors.

“If lots of investors want their money out, commercial property funds may need to sell one or more properties to generate the funds required and this can take time, possibly six months or more,” said O’Neill. “This is why investors in some commercial property funds were faced with six month ‘deferment’ periods in 2008.”

Concerns over liquidity can also affect returns, as open-ended fund managers hold on to some gains in order to bolster their cash buffers. That’s one reason why the average fund in the IMA property sector is up just 6.9 per cent over the past year, compared with the increase of almost 20 per cent in direct commercial property.

Commercial property funds either invest into the sector directly – in actual bricks and mortar – or indirectly into property equities. Perhaps the biggest advantage for ordinary investors lies in the diversification provided by bricks and mortar funds in particular, due to a relatively low correlation with other assets.

“Commercial property is not a one-way bet, but can be an excellent diversifier in a portfolio that only contains government bonds and equities,” said O’Neill.

But for many investors the biggest attraction of property funds is the income they pay, especially with so little available on cash savings. Around a dozen property funds currently yield 3 per cent or more, according to the IMA, including three above 4 per cent and one – the Schroder Global Property Income Maximiser – paying almost 7 per cent.

One way to gain from the growth in commercial property is through funds offering exposure to global property shares, according to O’Neill.

“Buying a fund which invests in companies that manage portfolios of commercial property can provide indirect, but liquid access to the asset class and would allow global, rather than just UK exposure,” he said. “As these funds are valued daily, the volatility appears higher than bricks and mortar funds, so this needs to be borne in mind if adding such a fund to your portfolio.”