How far can the commercial property rebound go?
Traditional investment wisdom has long viewed commercial property as a key element of a well-diversified portfolio - much less volatile than equities, largely unaffected by the ups and downs of the stockmarkets, and ideal for investors looking for a reliable income stream with steady capital growth.
The past two and a half years, however, have knocked those assumptions for six: having enjoyed a five-year capital growth rally of more than 50% to July 2007, the UK commercial property market fell by 45% over the next 25 months.
The run by investors on some funds, including offerings from Norwich Union, New Star and Standard Life, was enough to force them to close their doors to redemptions.
A year ago, only the hardiest bargain-hunters were following the stony commercial property trail. But a year can be a long time as far as market fortunes are concerned.
The massive fall in property values pushed all-important rental yields - rental income expressed as a percentage of capital value - way above long-term average levels.
As a result, property became an increasingly attractive proposition compared with other sources of income.
As a consequence of the impressive yields available, last July saw investors starting to return to the market and capital values beginning to rise again, and that trend has strengthened steadily since.
The latest Investment Property Databank figures show record-breaking capital growth of 7.4% for the last quarter of 2009.
Capital growth has been further fuelled in part by a lack of supply, as the flow of developments pretty well dried up with the collapse of the market.
"Banks have also been reluctant to sell repossessed assets at the bottom of the market," reports Ainslie McLennan, co-manager of the New Star UK Property fund.
Is enthusiasm justified?
The autumn turnabout in property valuations was picked up on in a big way by canny investors.
Property funds were the best-selling retail fund sector in both October and November 2009 (the most recent months for which statistics have been released), according to the Investment Management Association.
But is their enthusiasm justified, looking ahead to another very uncertain year?
It seems so. Improving valuations have led to some tightening of rental yields, but they remain very competitive.
"Yields are currently averaging around 6% to 7%, but that is somewhat misleading as a long-term trend because prices have fallen so much; a more typical property fund yield average would be around 4% to 5%," suggests Justin Modray, director of the financial website candidmoney.com.
However, Sheridan Admans, investment adviser at The Share Centre, adds that although yields are relatively high, they "are not likely to come down excessively in the near future".
Moreover, although capital values have recovered by maybe 10%, they remain a third lower than the July 2007 peak.
Direct and indirect ways to get into property
There are two main routes into commercial property for Isa investors looking for a piece of the action.
Some funds, for instance M&G Property Portfolio and SWIP Property Trust, are directly invested in bricks and mortar - typically, 70% to 80% of the fund will be in physical assets, with the balance in cash and shares to provide the necessary liquidity should there be a run on the fund, although these funds are more illiquid compared with, for example, investing in property companies.
Modray, however, points to the positives: "First, they provide genuine asset diversification for your portfolio because they are not focusing on equities, and second, they tend to produce a more consistent and higher income than indirect funds."
The alternative route is the indirect one, via a fund such as Aberdeen Property Share. Indirect property funds invest in a portfolio of shares in listed property companies and real estate investment trusts (REITs), which in turn invest in physical properties.
The funds may be subject to stockmarket volatility because they hold actual equities.
On the other hand, there is arguably potential for higher returns from these funds because they benefit from short-term stockmarket sentiment as well as that of the property market, and also because property companies can gear up to boost their investment exposure.
Another ISA option is a global or UK ETF (iShares offers some). These also track property companies and REITs rather than physical property prices.
Alan Dick, managing director of Forty Two Wealth Management, favours them over bricks and mortar because of their cheapness and liquidity, and the transparency of their pricing.
"I'm wary of anything based on assessed valuations - someone's guesswork - rather than traded market valuations," he explains.
If you hold a self-select ISA, you also have the option of investing directly in these property companies or REITs. The advantage of REITs versus conventional property companies is the tax treatment of income payments.
So what's the best bet for your ISA? In the current conditions, most advisers are in favour of bricks and mortar funds. First, says Modray: "Investors are going into property for income and/or diversification, and physical property is a better bet in those respects."
Moreover, says Admans, indirect funds are risky at the moment. "Property company share values have moved up with the stockmarket bull run and there's a real risk that they are trading at a premium to their net asset values; certainly they're already fairly valued.
"That leaves investors particularly vulnerable if the stockmarket suffers a double dip."
Of course, not all direct property funds are focused on the same type or quality of commercial property.
In the current wobbly economic climate most commentators recommend looking for funds concentrating on prime properties, with top-quality, recession-resistant tenants on long leases.
Adrian Lowcock, senior investment adviser at Bestinvest, also stresses the need to look at the amount of cash being held.
"Some funds have seen large sums coming in from investors, but it takes some time to invest that money in properties, and in the meantime the cash drag is diluting returns on the invested portfolio," he explains.
The New Star UK offering, with around 85% prime holdings, an average lease length of almost 11 years, low vacancy rates and a yield of 7.6%, is recommended by Lowcock and Modray.
Finally, don't go over the top with property. Lowcock suggests allocating a maximum 10% of your portfolio; Modray says 5% to 10%, although up to 20% might suit a cautious income-seeker.
The pros and cons of investing globally
Although overseas property funds have performed strongly, there's little enthusiasm for them.
First, most hold property securities rather than bricks and mortar. Second, says Martin Bamford, managing director of IFA firm Informed Choice: "There's a currency risk to build in, and potentially also other risks - political instability, natural disasters, corruption."
Third, says Lowcock, the UK is attractive, as sterling is weak and prices are very low.
However, Lowcock adds that a global fund may be "worth considering" as a spicy addition for investors with larger portfolios who already have a UK property holding, and recommends Schroder Global Property Securities.
Alternatively, suggests Modray, global property ETFs are a cheap way to access international property - "but you need to understand you're buying equity market exposure as well as property".
Investment trusts are another possibility. UK property investment trust discounts narrowed markedly last year as sentiment swung around (from 50% in January to an average premium of 11% in December), but that recovery has not taken hold elsewhere.
Charles Cade, head of research at Numis Securities, says European and emerging markets property trusts should feel the benefit in 2010 as a result of debt renegotiations, economic recovery and shareholder activism. He picks Invista European and Raven Russia as good bets.
This article was originally published in Money Observer - Moneywise's sister publication - in March 2010
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.
Sometimes known as a trading ISA, a self-select ISA gives investors full control over which assets to include in their ISA, allowing them to choose individual shares and bonds rather than investment funds. Aimed mainly at experienced investors and subject to the same investment limits of a regular ISA, a self-select ISA will usually be managed by a stockbroker on an investor’s behalf.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
An Exchange traded fund is a security that tracks an index or commodity but is traded in the same way as a share on an exchange. ETFs allow investors the convenience of purchasing a broad basket of securities in a single transaction, essentially offering the convenience of a stock with the diversification offered by a pooled fund, such as a unit trust. Investors buying an ETF are basically investing in the performance of an underlying bundle of securities, usually those representing a particular index or sector. They have no front or back-end fees but, because they trade as shares, each ETF purchase will be charged a brokerage commission.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
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Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.