After being a fan of commercial property in the mid-90s, I turned bearish around 2001/02. This proved to be too early but property’s problems caught up with it eventually, as we all know.
At one stage, commercial property (which is primarily an income investment) yielded less than a 10-year gilt. This is simply crazy and a sign of the sector being far too expensive. Unfortunately, lots of investors got sucked into the sector at this stage due to spurious arguments of “diversification”. If an asset class is expensive, then “diversifying” into it does not make sense.
The problem was that during the bear market in shares from 2001 to 2003, commercial property sailed through it without any hiccough. This led to the delusion that it was completely uncorrelated with the stockmarket, which has now been shown to be false. Commercial property is now down by some 40 per cent from its peak, a fall that has been exacerbated by investors all wanting to sell at the same time.
This creates huge problems for unit trust managers, who cannot simply sell a property quickly and in some cases have been running out of spare cash in their portfolios.
However, one fund that has come out far better than most is the Threadneedle UK property fund run by Don Jordison and Chris Morrogh. They recognised very early that they would need a bigger cash reserve in this environment have navigated these turbulent waters with about half the fund in cash. Not only did this mean that any investors who wanted to sell have been able to get their money back but it has also shielded the fund from some of the sector’s losses.
Perhaps the best advantage, how- ever, is that the fund is now superbly placed to start picking up properties at knock-down prices. The fund’s size of £42m might look small for a commercial property fund but in fact it means they do not get sucked into buying huge properties and can rather cherrypick those that are smaller.
It is especially interesting that the properties within the fund now yield 8.3 per cent, which is a great sign that it is time to start taking notice of commercial property again. Clearly, however, with such a lot of cash in the portfolio, the fund as a whole yields much less than 8 per cent. We all know that holding cash gives you very little return at the moment.
Threadneedle is finding good quality properties, often with the government as a tenant, but what they are really interested in is buying quality cash flow (not necessarily the best property). Consequently, this is why they are getting yields of around 8 per cent to 9 per cent on property that may still make them some capital profit in the years ahead but where the solid cashflow is the real draw.
I suspect at the moment it is still too early for private investors to start buying commercial property. The sector does depend on lending to some extent and volumes are obviously still low as the banks are reluctant to lend. So perhaps the best we can say is that, rather than the start of a recovery, this is the start of the end of the crash. Indeed, Don Jordison suspects that 2009/10 will see the low point in the commercial property market but no one will notice until 2011/12. He argues that commercial property should still be considered primarily for its income.
My message to you is to keep a close watch on funds such as this because at some point in the not-too-distant future there could be a great buying opportunity. Not that I expect anyone to take any notice – too many investors have been badly scarred.
Mark Dampier is head of research at Hargreaves Lansdown