Confidence rebuilding in bricks and mortar

Published on Friday 2 October 2009 21:03

THE commercial property market evokes nothing more strongly than the excess that triggered the economic crash. Investors piled into the asset class between 2005 and 2007, seduced by returns far higher than would normally be expected from commercial property.

Then it went pear-shaped, with so many people trying to pull their money out as prices plummeted that providers were forced to stop trading or introduce exit fees.

But now there is talk that it might be time for investors to consider bricks and mortar once again.

Standard Life, which was among those to introduce a waiting system for investors wanting out, is launching a new commercial property fund to take advantage of what it claims is "attractive pricing".

Aviva is following suit and BDO Stoy Hayward and Strutt and Parker last week joined forces to launch a UK Strategic Income Property fund.

So why the signs of life now? The Investment Property Databank (IPD) Capital Growth All Property index plunged by almost 45 per cent between June 2007 and July this year.

That might suggest the index has fallen so far that it can only go back up, giving investors a chance to get in at low prices. But unemployment is set to continue growing, reducing the demand for retail, factory and office space and depressing consumer spending, which further inhibits demand for property.

However, the IPD monthly index produced a positive return last month for the first time in almost two years, albeit of just 0.9 per cent.

The big attraction for investors is the yield on offer, particularly with savings returns still low, and the IPD property benchmark index currently yields nearly 8 per cent, more than double the yield available on gilts.

Ken Taylor, managing director of Mackenzie Taylor Wealth Management in Nairn, said commercial property was again worth some investors considering, albeit those looking for income rather than growth.

"The effective yield on a property fund is probably around 4 per cent, so it compares favourably to cash deposit rates. If you take the view that deposit rates are likely to remain low for some time yet, then property looks attractive."

Investors should not look to the sector for capital growth, however, added Taylor. "I see little likelihood of capital uplift in commercial property over the next period, though it is perhaps likely that the declines have halted," he said. "Therefore, the return for the investor is going to be based on income yield."

For the average investor, the role played by commercial property is as a diversifier, with a relatively low correlation with cash, bonds and equities.

Commercial property has historically been considered a bond-style asset offering income and diversification, but the high values of the mid-2000s saw the sector take on equity-market characteristics. Investors expecting a return to those heady heights will be disappointed, warned Barry O'Neill, chartered financial planner at Thomson Shepherd in Aberdeen. Instead investors should expect returns to fall between those provided by bonds and equities, reflecting the risk profile of the sector.

"We use a range of 5-7 per cent a year as an estimate of returns when advising clients on what would be realistic to expect over the long term," said O'Neill.

There are several ways of gaining exposure to the sector through collective investments, including real estate investment trusts, property share funds and bricks and mortar funds. The latter, investing in physical property, are the most effective in achieving diversification, according to O'Neill. "The asset class certainly has merit as a diversifier in a portfolio, provided you invest in bricks and mortar rather than property securities, which are more closely correlated to mainstream equities."

As the past two years have proved, investors seeking exposure to commercial property through collective funds need to tread carefully. One of the most popular funds of the boom period, the New Star International Property fund – now the Henderson International Property fund – is still suspended, while others are still locking investors in until they can offload more properties and recover sufficient liquidity.

O'Neill likes the Swip Property Trust, run by Gerry Ferguson. He said: "Unlike other managers, he wasn't forced to sell the crown jewels during the bleak times of the past two years and actively built a war chest of cash which he's now starting to spend to take advantage of the attractive valuations currently on offer."

But Taylor advised investors going into commercial property funds to understand the risks. "Many property funds will carry exposure to the overstretched UK consumer via retail properties, and also to businesses who may experience trading difficulties in the coming years," he said. "So I would conclude that buying in at the currently depressed values is not by any means a safe bet for great returns."