The Bank of England's recent indication that interest rates will not rise for years means investors have to continue to look beyond cash for income. An area investors turned to traditionally but fell out of favour following the financial crisis was commercial property funds which invest directly in property. However, investors are once again turning to this area because of attractive yields relative to cash, equities and bonds, with the IPD UK Quarterly Property Index yielding 6.1 per cent (see our report from last month).
Chartered financial planner Informed Choice has recently moved to an overweight position in commercial property in its tactical asset allocation model, in contrast to neutral during the second quarter.
Insurance company Legal & General's house asset allocation view for August has a "Heavy" weighting to UK real estate, on the grounds that "The weak growth environment is expected to impact prices in the near term but yields remain attractive compared to other assets, suggesting returns above cash over a three-year holding period."
Gary Potter, co-head of the multi-manager team at F&C Investments, adds that bonds, in particular government and corporate debt, have had a good run but property has lagged this and may offer a better total return going forward.
Scottish Widows Investment Partnership forecasts the all-property total return to be 6.1 per cent over this calendar year - a considerable improvement from last year's 3.4 per cent. "Returns are also forecast to gradually improve over the next five years (from end of the second quarter of 2013), with an average annual return of 6.9 per cent a year over the next three years and 7.2 per cent a year over the next five years."
And Rob Pemberton, investment director at HFM Columbus Asset Management, says: "Property assets typically have long leases with upward-only rent reviews or in some cases rental uplifts based on Retail Price Index (RPI) inflation thereby adding inflation protection to this income stream."
Informed Choice also notes that as well as a reasonably good outlook for total returns, property is becoming more useful for diversification and risk management within a diversified portfolio.
Risks
But risks remain. The retail sector continues to be under pressure from falling levels of consumer spending and a shift in buying patterns away from the high street to online. Commercial property in the UK is still a very fragmented market, with variable outlooks across the regions," adds Mr Bamford.
Tenant default is a key risk, as is a downturn in the UK economy which can cause the latter.
Direct commercial property is highly illiquid - not easy to buy and sell. Lease lengths of typically five years or more are not negotiated and agreed overnight, points out Shaun Port, chief investment officer at discretionary wealth manager Nutmeg, while if a tenant suddenly vacates, renting, buying or selling the property can take months. This can cause funds to lower or cease dividend payments, or sharp falls in capital values.
Of more relevance to private investors is the risk at fund level. Funds are run by experienced teams who will try to mitigate the risks above. But property unit trusts, which should allow you to take your money out of the fund every day, have at times such as in 2008 suspended redemptions. This is because the fund may not be able to immediately sell a building to get the cash to give back to investors.
Since then property funds have taken steps to mitigate this. "Liquidity is always a risk so we and a number of other funds hold much higher liquidity buffers than in 2008," says George Shaw, manager of Ignis UK Property Fund (GB00B053C307). "As well as holding an appropriate liquidity buffer, cash and cash equivalents, we actively monitor flows. And in any case not all funds stopped redemptions in 2008, including our one."
But this means in rising property markets the fund may lag the average prices of commercial property. "The cash buffer to enable daily dealing means that while you should get a dividend yield of maybe 5 to 6 per cent less fees, in some cases it may be closer to 1 per cent," says Alan Higgins, chief executive officer at private bank Coutts.
For these reasons some argue that investment trusts, which are listed on the stock market, are a better way to invest in property as they do not have to meet redemptions. When their investors want to divest of their holdings they sell the shares, provided they can find a buyer.
Finding a buyer could be more difficult, however, if a certain trust or commercial property is out of favour, and the trust is trading at a wide discount to net asset value (NAV). You may be forced to sell your shares for less than you bought them, and generally listed vehicles are more volatile than unlisted ones.
Currently most investment trusts investing directly into UK commercial property trade at premiums to NAV, and the ones that have good performance records such as IC Top 100 Funds UK Commercial Property Trust (UKCM) and F&C Commercial Property (FCPT), are on excessive double-digit premiums of more than 13 per cent. This is in part due to their attractive yields of 6.87 per cent and 5.27 per cent respectively: many investment trusts offering attractive yields trade at premiums.
When deciding whether to invest you need to consider whether the trust offers value, according to Jane Heyman, chartered financial planner at McCarthy Taylor, and if it is trading at a premium then it is not. However, she says you also need to consider what potential there is for growth and whether the assets the trust invests in are under valued. "And we feel commercial property is," she says.
Ms Heyman adds that you should see if the premium is at its normal level, by comparing it with its historical levels, and take into account quality and a long track record, such as with F&C Commercial Property. "There is a case for buying a good investment trust at a premium if you are holding it for the medium to long-term, and it gives decent performance and yield. A premium can be recovered by the yield over 12 to 18 months."
But she says to try to time your purchase - if you see the premium fall then this could be a good moment to get into the trust.
However, Mr Potter argues "it goes against the grain to buy something that gives single-digit returns per annum that trades on a double digit premium."
Another downside to direct property investment trusts is that their share price could be influenced by the overall market, though Ms Heyman adds that they should offer more stability and diversification.
Source: Morningstar, *Henderson, **Ignis,, ***M&G,
Performance data as at 9 August 2013
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