Commercial Property Market
Commercial property has soared in popularity with investors. Insurance companies and fund managers have responded with new funds which have been rapidly snapped up. However some think this is a bubble that is about to burst.
High yield, steady appreciation
The attraction of commercial property is that it offers more than twice the yield on the FT All Share index, and unlike the interest on bonds the distributions should increase over time.
It should also achieve relatively steady appreciation, with the Investment Property Databank – which monitors UK commercial property – having shown a gain in all but three of the last twenty five years. In addition it has a different cycle to equities – doing well for instance in 2000 to 2002.
This prompts New Star, which manages a property unit trust, to suggest that including commercial property in your portfolio is likely to reduce risk and may smooth out overall returns.
Reliant on tenant demand
The snags include the worry that tenant demand in many parts of the UK and Europe has been slack for some time, and if this persists it will undermine rents and therefore returns.
"To be sustainable in the longer term, continued property value growth must be a consequence of rising rental values. That is not currently the position" says Chris Turner of TR Property Investment Trust, although he sees signs that tenant demand is picking up.
Outperformed by equities
Another consideration is that UK equities outperformed the IPD index in seventeen of the last 25 years, so property was only more rewarding in eight. If the recent stock market strength continues, then equities could be the better bet this year.
Management is key
Just as importantly, property portfolios need managers with the skill and commitment to look after the actual bricks and mortar, with all the attendant complications of rent gathering, refurbishment etc., and it is impossible to tell which of the newer funds have really first class teams.
"Property is different to shares. Only one investor can buy it and they must then run it," says Chris Turner. "A property company is a pile of assets and a pile of people. In the long run the more important pile is the people. So it is important to invest where the management is excellent and has demonstrated superior returns. I am sure there are some good managers of these new funds, but at this stage it is difficult to tell which have real talent and never have any empty space."
TR Property
TR Property itself could be good starting point for investors, especially as unlike property unit trusts it is ISAable, and its shares can be bought at a discount to net asset value. Its main drawback is that it only yields 2%.
Unusually for an investment trust, it is allowed to invest in direct property as well as property companies, but usually restricts the former to between 15 and 30% of its portfolio. Over the last three years it has reduced its direct portfolio to 8%, because it believes that property shares are a better bet in a strong market. It has been right, with its equity holdings appreciating by around 45% last year, compared to less than 20% on its direct holdings.
Property Shares
Turner explains that property shares have done better because they have benefited not just from the rising price of their real estate, but also from gearing, from takeover activity and from narrowing discounts. Hopes that the government will allow property companies to convert to more tax efficient Property Investment Funds have also boosted prices.
Turner expects commercial property to remain buoyant this year, with property shares doing even better. However he warns that returns are unlikely to be anywhere near as good as in 2004, and suspects that other sectors of the UK stock market could be a lot more rewarding.
Unit trusts
Unit trusts managed by Aberdeen, New Star and Norwich/Morley are the traditional alternative. The Aberdeen Property Share trust has much the best capital growth record because it invests in property shares, but its yield is minimal. The New Star and Norwich funds are mainly direct property, and therefore they are not ISAble and there can be moratoriums on trading if there is a rush for the exit. Both have achieved 3 year total returns of around 40%, with more of New Star's return coming from its yield, which is over 4%.
Norwich warns that "Property returns for the next thee years are likely to be nearer 7 to 8% rather than the 12% achieved in the past three."
Those wanting a yield of nearer 6% should consider UK Balanced Property, managed by Scottish Widows, Invesco UK Property Income Fund or Standard Life Property Inc. They can offer a higher yield because they are based offshore, and therefore enjoy greater investment flexibility and a more favourable tax regime. However all have been launched since July 2003 , so they have not yet had time to prove that they can make their portfolios work. In addition, the shares in all three stand at a premium to net asset value, which makes them look a bit expensive.
Source: Interactive Investor
Date: 03.03.05
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