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Is property starting to get shaky?

Property has become the increasingly favoured asset class for many investors over the last few years and money has been pouring into UK property funds.

The latest Investment Management Association statistics for August reveal the extent of property’s popularity as it was the most popular net retail sector for the eighth consecutive month, with inflows of 418m.

But some IFAs and analysts are warning that the sector in is showing signs of overheating and believe investors may be forgetting about risks involved with property investment after the last few years have produced stunning returns.

Is the property market due for a slowdown and are investors aware of the risks involved?

Morley property economist John Buckley says the firm is expecting returns to slow over the next three years and says the recent years of high teen returns cannot continue. He believes investors need to be realistic about the returns from property in the future. He says: “Property has returned 16 per cent over three years and 13 per cent over five years so it has had a very strong run but we think this is unsustainable and must slow. The reason for investing in property is that it is a useful diversifier because it has a low correlation with bonds and equities.

“People should still have a reasonable holding in property but if they think they will continue see the returns they have enjoyed over the last few years they are mistaken. It is a good thing if some IFAs are making investors aware that returns are likely to reduce.”

Buckley says yields from UK commercial property will reduce over the next few years but he believes the introduction of Reits next January will mean yields should be sustained at higher rates than would have otherwise been the case for the next two years.

Credit Suisse head of multi-manager Gary Potter is concerned over the property appetite and says some investors are buying into it because they believe it is more stable than other asset classes.

He says: “My concern is that there is too much money chasing too few opportunities now and some are investing in it without looking at the yield. People need to remember that while it is a good diversifier, it should be viewed as distinct from investing in rolling equities.

“If you can find the right property manager who is not being overburdened by liquidity pouring through the door, you will still find opportunities in UK property, although they are becoming more limited.”

Barings head of multi-manager David Coombs says he has been reducing exposure to UK property over the last few months and now has the maximum of 30 per cent non-UK property in the Barings multi-manager property fundHe thinks the sector is becoming overheated. “If you look at the New Star property fund, it is now advertising a yield of 3.7 per cent which is not as attractive as previously,” he says.

Coombs is encouraged by the recent scaling back of some of the more ambitious plans for the London office market which could have led to an oversupply of prime rental sites but he has still reduced UK commercial property exposure.

He says: “I have been overweight in commercial property for three years but I have been reducing exposure, taking some profit and built up my cash and overseas property exposure.”

“The correlation with equities has increased. Three years ago, commercial property was being sold as a low-volatility asset class somewhere between equities and bonds but now short- term volatility has moved up a little.

“I do not think property returns will fall but they will flatten out although the sector is still attracting huge amounts of private investment,” he says.

Premier Asset Management pan-European property fund senior investment manager Alex Ross says European property yields are returning 6 six per cent combined with decent rental growth, making them generally more attractive than the UK sector.

Ross believes UK commercial property investors need to break down the market into the three distinct sub-sectors of office, retail and industrial to get a better understanding of the risks involved.

Over the last three years, all the sub-sectors have moved up together, driven by the weight of money. No Ross says things have changed and the office sub-sector, particularly in London, could continue to outperform the other two in the longer term.

He says: “Commercial property is highly cyclical but the London property office market is still very favourable. In the last 12 months, vacancy levels in London have been less than 4 per cent so it should continue to give attractive returns for the foreseeable future.”

Ross believes the industrial sector is holding steady although he says risk premiums need to be watched but it is in the secondary retail property market in high streets and secondary shopping centres where Ross believes the risk lifes for investment risk.

He estimates that such sites can generate a yield of 250 basis points higher than on prime sites such as the London office market but the longer-term risks are greater.

He says: “In this area, the risk premium is overvalued. People have lost touch with why you have a higher-risk premium. Yields may appear more attractive now than in primary sites but in an economic slowdown this type of property will get lower quality tenants and returns could drop off.

“Investors can forget that this is why such areas have a high-risk premium in the first place.”

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