David BurrowsWhat are the prospects for UK Commercial property funds after a tough year and with Brexit beckoning?
The outlook looked bleak for property investment when, following the EU Leave vote, there was a significant increase in the number of investors exiting or reducing their UK commercial property exposure.
If Brexit jitters weren’t enough, there were then corroborated reports of the Chinese government massively pulling overseas property investments globally in the first half of 2017 – with the UK market an obvious casualty.
The Brexit effect
Taking Brexit as an issue first, was the exit from UK commercial property an illustration of panic rather than reason?
Martin Bamford, chartered financial planner at Informed Choice, believes so. “Investors engaged in a knee-jerk reaction following the EU Referendum result last June. This resulted in some property funds delaying redemptions or revaluing assets. As is usually the case with investing, those investors who avoided panic and stayed put in the funds did not suffer financially.”
In fact, the EU referendum result provided a boost to property investment – at least in some quarters. As Patrick Connolly, at financial advisers Chase de Vere explains. “While Brexit has caused uncertainty for the prospects of UK property, the weakness we’ve seen in sterling since the EU Referendum vote has made property cheaper for overseas investors.
Many UK property investors exited the market post Brexit
Property investment from China
The second issue is Chinese investment. This has continued, just not at the same pace as previously. Also, China is not the only overseas investor in the UK market – according to research from CBRE, there has been strong interest from UAE, US, Hong Kong and mainland Europe.
That said there are currently concerns about the UK property market. The Royal Institute of Chartered Surveyors recently described the London property market as "stagnant." Given that London and the South East has been central to the strong UK property story – is there reason to be doubly cautions of investing in UK focussed property funds?
“London and the South-East regions are facing challenging times and the average property fund has about 60% invested in these regions,” Connolly explains.
“This could impact on performance, although sentiment generally has improved in 2017 and investment managers are predicting returns of around 7% per annum in the coming years.”
Bamford agrees that property funds with a narrow UK mandate are not hugely enticing. “We always recommend property funds that have a broad geographic and sector spread. Relying too much on London retail, for example, would be a risky prospect in light a shift in consumer behaviour towards online shopping and high property prices in the City.”
Bricks and mortar
For those new to property investment, it is important to understand the different nature of funds offered. Some invest mainly in the shares of property related companies and don’t buy any actual buildings where as others will invest predominantly in real ‘bricks and mortar’ properties
Connolly at Chase de Vere explains that he only recommends commercial property funds that invest in ‘bricks and mortar’ property.
“They have far less correlation to the stock market and are less volatile than investing in property shares. Funds we use include M&G Property Portfolio, L&G UK Property and Henderson UK Property.”
It maybe that the double-digit returns offered from property funds back in 2014 will not be repeated – for the foreseeable future at least but projected returns of around 7% still compare favourably with cash on deposit and investors are always advised (for diversification purposes) to have some exposure to property at any given time.
Realistic expectations
Bamford agrees that investors should have more modest return expectations for the future, especially with the threat of rising interest rates. But he insists commercial property still has good total return prospects, due to its healthy yield profile.
It also plays an important role within a well-diversified portfolio as it tends to be negatively correlated with bonds and equities.
Connolly takes a similar line: “Commercial property can provide consistent income and long-term returns and this coupled with its diversifying nature, providing some protection from stock market falls, means that most investors should hold commercial property funds in their portfolios.”
He adds: “Investors in property funds need to take a long-term perspective, as a minimum this will be 5 years, but ideally 10 years or more.”
Is property investment too illiquid?
One of the concerns with ‘bricks and mortar’ funds is that by their very nature they can be illiquid. With this in mind, the best way to manage liquidity risk is to keep commercial property exposure to a relatively small proportion of an investment portfolio.
Connolly explains that the general rule of thumb is for clients to typically have between 5% and 12% of their portfolios in commercial property.
It is difficult for investors to know where to invest at present, with stock markets riding high, many fixed interest assets looking expensive and the outlook for commercial property uncertain with the UK withdrawal from the European Union on the horizon.
The best approach for investors, as usual, is to cover most bases rather than channel money exclusively into one area.