Property is in an asset class all of its own

A WEEK is a long time in the investment markets.

The unexpected quarter point increase to interest rates and inflation's rise to 3 per cent - a smidgen away from Mervyn King having to send Chancellor Gordon Brown that letter of humiliation - have left many investors a good deal less confident. Meanwhile, sudden talk of negative equity and the likelihood of a further interest hike in February by the Bank of England's monetary policy committee has left property aficionados scratching their heads.

But don't forget most of us live in our best investment, while a few of us have further improved this good work by including commercial property in our self-invested personal pension (SIPP). Thirdly, some of us may have acquired property shares, which could have delivered an astonishing 20 per cent annual growth over the past five years.

If, dear reader, you have done all these things, you can afford to be smug but you may be wondering how long these good times can last.

What I can tell you is that this period of stellar property appreciation has forced many investment professionals to refocus on the idea of investing in this new asset class, which can deliver value and an income yield with little connection to traditionally accepted Footsie equities. Traditionalists have thrown up their hands in horror but it does seem that this is now the way forward, with property investment attracting many new disciples.

However, as we all know, what goes up very fast can perform equally impressively on the downside.

Nonetheless, after December's report from a major agency that central London residential property had soared by a truly mind-blowing 26.6 per cent over the past year, even the most reluctant investment adviser is going to find it increasingly difficult to ignore the performance market of the moment.

The fact is that a range of property-related investment vehicles have emerged as a result of this increased investor demand. The assets have varied from direct property investment portfolios and funds through to unit trusts and investment trusts. In parallel, a positive mushroom-cloud of buy-to-let activity has effectively created millions of new investment-orientated portfolios. The scale of this migration of funds into property assets is demonstrated in What Investment magazine's recent research into five years of comparative growth of the FTSE All Share index with three property indices - the ABI Life Fund Property index (containing a mix of mainly commercial property-based funds), the seasonally adjusted Halifax Property index (UK residential property) and the IPD All Property Monthly index (commercial property portfolios).

Over the 60-month period, the FT All Share has delivered a 36.6 per cent return, which is pretty good as equities were still in a state of post millennium decline for the first third of this period. The ABI Property Fund index had climbed an impressive 68.3 per cent, The Halifax house price index recorded a massive 87.9 per cent but all had been outperformed by the IPD All Property index, which has risen by 97.5 per cent.

The attraction of property as an investment is simple to understand based on the above growth statistics.

As a statement of fact, one of the best sectors for anyone's investment funds over the past five (and indeed ten) years would have been commercial property. However, at the beginning of 2006, equities moved ahead, with some pundits forecasting a slow-down in commercial property returns. But it never happened, with burgeoning market conditions prevailing throughout the year, attracting the attention of overseas investors with some very deep pockets - according to What Investment, Middle East buyers made up 30 per cent of the UK commercial property market in this latest year.

However, sense looks likely to re-emerge, with commercial property pundits forecasting declining returns over the next 12 months. Nonetheless, the introduction of REITs (real estate investment trusts) designed for private investors may provide a balancing uplift to the market. However, this may be temporary as the latest interest rate rise - with more to come - puts a further dampener on commercial property yields and thus capital values.

In summary, commercial property must still represent a buy, taking a medium term view, with the Scottish market standing out as a relatively strong opportunity.

The residential market is subject to a range of quite different factors, but the fundamentals seem to indicate a continuation of bullish conditions in residential property throughout the UK with, perhaps, the probability of even better growth north of the Border in 2007.

As a new asset class in a diversified private portfolio, property cannot be ignored anymore.

• Yuill Irvine is managing director of IFA firm Dunedin Independent