Commercial property is on the news agenda. Billed as the go-to for yield and diversification, investors would be forgiven for thinking it was a sure thing.
But advisers are warning that commercial property is one of the riskiest assets, and only suitable for a handful of investors.
The sector does look compelling. The Royal Institute of Chartered Surveyors this week revealed that house prices were rising at their fasted pace in seven years, meaning property inflation has returned to pre-recession levels. Although residential and commercial property are not 100% correlated, figures from the Investment Property Databank (IPD) revealed that UK commercial property rose for the third consecutive month in July.
Overseas demand is pushing up prices, as commercial property in London and the South East gets snapped up by Asian and Middle Eastern investors looking for a tangible asset in the UK.
Add to that, the low-interest rate environment has had a two-fold positive impact on the property market. Bank of England base rate has been at a record low of 0.5% for more than four years, meaning developers can borrow money cheaply, and investors need an asset that provides an income – as cash no longer pays. These conditions look set to continue – thanks to Bank of England governor Mark Carney’s proposals last week to link interest rates to the unemployment level.
Property funds are yielding around 4% - compared to 2.7% for a 10-year gilt and not much more from the corporate bond market.
Henderson UK Property is yielding 4.7%, Threadneedle UK Property yields around 5% and Standard Life UK Property is yielding 2.9%.
With inflation still riding high at 2.8%, property seems to be one of the few investments that will actually generate a real return. Equities look more attractive - volatility aside, the FTSE 100 is up 12% since the beginning of the year. But you cannot build a diversified portfolio out of equities alone.
Property fans cite the asset’s high and stable income as a reason to invest - in the decade to 2012 income accounted for 6.2% of the 6.4% annual return.
The IPD UK Property index seems to back this up, it is currently yielding in the region of 6.5%, the FTSE 100 comparatively yields around 3.5%.
(Source: IPD Index)
But this headline figure is misleading. Commercial property yields almost halve once you have applied charges - meaning the take home income is closer to 3%.
When you have equities such as Resolution yielding 6.5% or AstraZeneca at 5.6%, then property looks less appealing.
There is also the issue of liquidity. In 2008, commercial property investors were unable to access their cash as several funds imposed exit restrictions. These open-ended funds – including offerings from Aviva and the now-defunct New Star - faced a deluge of sell requests as the property market crashed and investors wanted out.
However due to the structure of the funds the management was unable to fulfil their wishes as they couldn’t offload the property fast enough. Property is illiquid, unlike stocks which can be bought and sold electronically in a matter of seconds property is slow to trade and has high transaction costs.
Managers say they have taken steps to ensure that this situation will not arise again – putting in ‘liquidity buffers’ in the shape of a larger cash allocation.
But the nature of an open-ended property fund is such that when there are mass inflows it is most likely to be at a time when investable assets are difficult to source, and mass outflows come at a time when all the manager wants to do is preserve cash.
Of course a portfolio made up solely of equities is not well diversified, but many investors often fail to consider their existing property exposure before buying funds.
For most people their largest asset is their home. Consider your assets as a whole - property, pension and investments and many people have a considerable proportion of their estate already in bricks and mortar. That diversification already exists.
For the long term investor property does have its value. In a closed-ended fund, as a small part of a portfolio it can provide a diversified source of income and in a thriving UK economy rental rises provide a hedge against inflation. However investors should consider their existing assets and their investment horizons before buying.
