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Property sector focus: Caution is the key

Annie Shaw reports that investors are being attrac ted back to the commercial property sector by imp roved prospects but they are being urged to tread carefully with their choices

Many investors who flocked into commercial property funds four or five years ago found themselves badly burnt when the market crashed in 2007.

Now, just as the embattled sector is showing signs of recovery and income-seekers turn to bricks and mortar funds again in pursuit of higher yields, there are fears that investors might not fully understand the risks that are peculiar to this sector.

Informed Choice managing director Martin Bamford says: “These funds have experienced some quick gains over the past few months, with the IMA property sector up by 9.12 per cent over the past six months.

“They remain about 30 per cent lower from their high point three years ago and, with many funds offering attractive yields, can continue to represent a good buying opportunity for part of a well diversified portfolio.

“As the economy emerges from recession, we expect the prospects for these funds to continue to improve.”

Hargreaves Lansdown head of research Mark Dampier also thinks it could be time to venture back into commercial property – but with caution.

He says: “We are seeing a bit of a recovery but I would not go overboard. Many of the funds now have too much cash and cannot invest it quickly enough. This means that most funds have sub-4 per cent yields, even though commer cial property is supposed to be largely about income.”

Dampier also has concerns about the prospects for income in the future. “Rents are falling,” he says.

“The banks are natural sellers, as they have about £100bn too much of the stuff, and, to cap it all, the UK economy looks awful for the next few years.

“That said, commercial property has fallen a long way and the fall of sterling makes it look cheap for overseas buyers. All in all, it might be worth having something around 5 per cent in it but not the 20 per cent plus we saw suggested a few years ago.”

Several fund managers have also suggested that a cautious approach might be merited.

Fund manager Ignis recently warned investors in its £510m UK property fund that rental growth looks likely to be “anaemic” for the next 12-18
months. It added that there was little reported easing in the availability and cost of debt finance, which “in conjunction with the fragility of the wider economy, contin ues to cast an air current recovery”.

M&G pro perty portfolio manager Fiona Rowley says although investor sentiment continues to remain buoyant, largely due to the attractive yields, the outlook is not entirely positive.

She says: “Despite the attractive yields offered by property, the market rally we are experiencing is not based on any material improvement in the underlying fundamentals for property. Conditions in the commercial property occupier market remain challenging. With the close correlation between GDP growth and rental income growth, investors should remain alert to the implications of an uncertain economic outlook.”

The FSA is also keeping a close eye on the property sector. Earlier this month, it published its annual Risk Outlook, which included details of new stress tests for banks. It expressed concern over the £160bn of UK commercial property debt due to mature the next five years, which could put new pressure on the banks.

If the banks were not able or willing to renew lending, the report warned: “This could force liquidations and release commercial properties on to the market, possibly triggering further price falls.”

Henderson Global Investors senior property research manager Mike Keogh says returns should hit double digits in 2010, partly due to the weight of investor money coming in, but he also believes there could be a correction at the end of the year. “This stabilisation in yields, or even slight fall in values across nonprime assets where occupier threats have materialised, is likely to produce relatively modest returns in 2011.”

But in the longer term, property could still offer investment opportunities. Yellowtail Financial Planning managing director Dennis Hall says: “Not just any fund will do and there needs to be a bit more research than simply scrolling down the performance tables. Funds with the right property with the right tenant are no longer priced at bargain basement levels and funds that scream cheap should probably be avoided.

“Investing in funds that adopt sound fundamentals will pay long-term dividends – in every sense of the word. Tenants still need to pay the rent.”

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