Concrete investments?

Posted On Monday, 30 September 2002 10:01 Published by
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With commercial property yielding about 7 per cent a year, it is no wonder that investors are being tempted to divert money from other assets into property funds.
Bricks and mortar have never looked so appealing against the backdrop of relentless stock market falls.

And with commercial property yielding about 7 per cent a year, it is no wonder that investors are being tempted to divert money from other assets into property funds.

But it is difficult for the average retail investor to obtain exposure to commercial property and advisers are concerned that they are not aware of the risks.

Since 1987 commercial property returns have averaged 10.4 per cent a year, according to the Investment Property Databank (IPD), made up of 7.8 per cent a year income return and 2.7 per cent a year capital growth. Over the last 12 months property has returned 9.4 per cent against a 19 per cent fall in equities and 7.4 per cent rise in gilts.

With these sorts of numbers it is no wonder that financial advisers are enthusiastic about the asset class. But the substantial increase in flows of money into the sector are leading some to sound a note of caution.

'If you can see a bandwagon, you've generally missed it,' says financial adviser Michael Gough of Jelf Professional Consultancy. 'The asset class is being touted as low-risk and high-return and I'm worried that people may not understand the risks.'

The funds covered by the IPD, a partial sample of the sector as a whole, experienced a net inflow of {GBP}197m in the first half of 2002, compared to a net outflow of {GBP}123m in the first half of last year. IPD warns: 'The renewed appetite of institutions for property when rental growth is running at just 0.6 per cent per year might seem like 'irrational exuberance'.'

Gerardine Davies, fund manager of Norwich Property Trust, the largest authorised property unit trust in the UK with {GBP}600m in assets, says that strong inflows from institutional and retail investors seen in recent months can cause problems. 'There is a lot of competition for good assets like quality retail warehousing,' she says.

High investor demand may be ignoring the possible risks overhanging the sector. Legal & General points out that over the past 20 years, real commercial rental growth has averaged zero per cent per annum. 'We believe that in the long-run, real rental growth can also be expected to be zero.'

Weakness in the economy has been reflected in the woes of office space providers like Regus and in falls in office rental values. A Royal Institute of Chartered Surveyors' survey says that sales and lettings of commercial property to businesses fell in the second quarter, and at a sharper pace than in the first quarter.

Ms Davies also points out that supply, particularly in London where the office market is weak, has gone up when business sentiment in general is poor.

But most observers say that although there are areas of weakness in the sector, there is little sign of an imminent property crash on the scale of the early 1990s.

'In the recession of the early 1990s, negative returns were achieved from commercial property, but this period was characterised by rapidly rising interest rates and contracting tenant demand,' says Anthony Wyld of Close Property Investment. A study by De Montfort University earlier this year pointed out that although the {GBP}80bn in loans made on commercial property in 2001 was a 25 per cent increase on the year before, the aggregate value of problem loans was only 1 per cent, much lower than the levels of the early 1990s.

Chartwell Investment Management argues that low vacancy rates also show how different the situation is from a decade ago. It expects commercial property yields to remain above 6 per cent a year and total returns at about 9 per cent a year.

These forecasts risk extrapolating too much from past performance. Nevertheless, for investors who are prepared to take a long-term view and are aware of the risks, the benefits of investing in commercial property still seem appealing.

Many may already have money in the sector via their pension schemes or life assurance policies and fund managers say pension funds and life companies are increasing their investment. Pension funds now invest about 4 per cent of assets in property, but in the early 1980s a more typical level was 15 per cent. Rupert Sheldon, fund manager of the {GBP}190m Henderson Property Fund, says there is a long queue of pension funds trying to get into the fund.

The options for the retail investor, however, are limited. There are few collective investments in commercial property and most do not qualify for inclusion in an individual savings account. One exception is the {GBP}300m TR Property trust run by Henderson Global Investors, which has been in the list of top 10 Isa funds over the last three years.

Property bonds from life companies are one alternative although financial advisers warn that they can be difficult to cash in and often carry high charges. High net-worth individuals can invest in funds such as Close's Prime Property Limited Partnerships, although the minimum investment is high and funds are illiquid.

The costs of managing a property portfolio, such as legal fees and stamp duty, are higher than those associated with equities or gilts. At times of high demand for property funds this does not matter too much as sellers can be matched with buyers. But if the situation was reversed sellers would find it hard to dispose of assets.

Investors also must be clear about what their property fund is investing in. Property unit trusts must hold a large portion of their assets in cash so that investors can make redemptions without delay.

The Edinburgh Portfolio Property Fund, run by Capital & Counties, has a whopping one-third of its assets invested in cash and property-related stocks such as housebuilders. The fact that property funds hold shares as well as bricks and mortar means that investors need to beware of doubling up equity exposure. Copyright Financial Times Limited 2002. All Rights Reserved.

Financial Times

Publisher: Financial Times
Source: Financial Times

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