Commercial property funds offer investors the opportunity to partially own commercial buildings such as retail units, warehouses, factories and offices.
Direct commercial property funds or “bricks and mortar” funds are pooled or collective funds where a professional manager collects money from a number of investors, then invests the money directly in property.
The fund spreads risk by investing in a number of different properties while returns come from a combination of rental income and capital growth.
There are several advantages to investing in commercial property as opposed to residential property. Leases for commercial property tend to be for a minimum of five years and annual rent reviews normally mean rents rise by at least inflation each year. Rent default rates also tend to be lower than for residential buy-to-let property.
Another key difference from buy-to-let is that the fund manager will identify which properties to buy, and manage the properties and tenants, offering investors a hands-off investment.
Commercial property has been in a sweet spot in recent years, with the asset class notching up double-digit returns in 2013, 2014 and 2015, with a rise in economic growth helping drive the boom. However, recent events have highlighted some of the downsides of direct commercial property funds.
In normal circumstances funds have a cash buffer to cover withdrawal requests. But the trouble is this cash won’t be enough if large numbers of investors want to make withdrawals at the same time and this could force the fund manager to sell properties to meet redemption requests. But selling commercial properties in uncertain economic conditions – such as now – could mean the fund manager would not be able to realise their full value.
So to protect other investors, funds have “lock out clauses” which allow fund managers to shut off payments to investors wanting to exit the funds if there are "exceptional circumstances." Some funds have invoked these lock out clauses following the EU referendum result.
The past couple of weeks have seen a number of commercial property funds run by companies such as Henderson Global Investors, Canada Life, M&G Investments, Aviva Investors and Standard Life Investments halt withdrawals to investors.
This means savers cannot access around £15bn of cash currently tied up in the funds. The lock ins echo what happened at the start of the financial crisis in 2007.
Tom Stevenson, investment director for personal investing at Fidelity International, is in two minds about whether investors would be right to redeem their money from a property fund in the current climate.
“Being locked into a commercial property fund may not be the worst thing to happen if it prevents a hasty response to a change in sentiment,” he says, “Property investing is necessarily long-term and investors should not look to jump in and out of funds investing in this relatively illiquid sector.”
Other property fund options
Investment trusts that invest in commercial property are a type of fund that lists on the London Stock Exchange. They are closed-ended which means they don’t have to sell properties when investors want to take their money out. However, the share price of the trust will fluctuate in line with investor demand. Sometimes commercial property investment trusts will trade at premiums to their underlying assets. At present, many are trading at discounts to their underlying assets.
Indirect property funds buy shares in companies that invest in property. Rather than making money by capital growth and rental income, returns are gained through share price appreciation and dividend income like any other investment in shares. This means investors don’t have the liquidity problems of direct commercial property funds and can move in and out of the fund freely.
UK property funds investing in bricks and mortar, property shares or both
|Fund name||Initial charge||Ongoing charges|
|Aberdeen Property Trust||0%||0.87%|
|Henderson UK Property||0%||0.85%|
|Kames Property Income||0%||0.96%|
|M&G Feeder of Property Portfolio||0%||1.11%|
|F&C Global Real Estate Securities||0%||1%|
|F&C Real Estate Securities||0%||1.45%|
|F&C UK Property||0%||0.91%|
|Premier Pan European Property Share||0%||0.97%|
|TM Hearthstone UK Residential Fund||0%||1.72%|
Source: Tilney Best Invest on 15 July 2016
Don't miss the previous articles in this series:
- Our national love affair with property
- A history of property prices
- Property versus pensions
- Buy to let: Buying a property
- Buy to let: Letting it out
- Buy to let: new taxes for landlords
- Understanding property taxes
- Alternative ways to invest in property