Commercial property may have enjoyed a stellar three years but fund managers warn returns are likely to be more muted in the coming months as the effects of economic pressures bear down on the market.
The sector has enjoyed double-digit growth, driven by a combination of income, capital growth and strong demand from overseas buyers who were attracted to key markets, such as central London. But the prospect of interest rate rises and the forthcoming EU referendum have forced people to put their investment plans on hold, said Marcus Langlands Pearse, co-manager of the Henderson UK Property fund.
Markets under pressure
‘The sector under most pressure is likely to be the central London market, until Brexit is determined,’ said Langlands Pearse. ‘Many overseas buyers have suspended further investment, particularly in the larger lot sizes.’
The retail sector is undergoing structural change due to the growth of internet shopping and convenience grocery shopping. So Langlands Pearse has been focusing on other areas of the market.
‘The fund has benefited from increasing its exposure to the alternatives sector, which includes hotels, leisure, student accommodation and data centres. We have been attracted by the prospect of long leases, strengthening covenants and good relative pricing in the sector,’ he said.
Gerry Ferguson, manager of Aberdeen’s SWIP Property Trust, is also more nervous about the outlook. In the past year he has been derisking his portfolio and looking at ways to maximise income from his existing holdings.
‘We sold more than £200 million of central London stock last year, and we haven’t expanded our development programme,’ he said. ‘We’ve also been working to reduce vacancy rates and all our purchases have been solid acquisitions that don’t require much capital expenditure.’
Ups and downs
The property sector has been through plenty of challenging periods. In the boom years, it benefited from companies looking for space to expand, so investing in funds that owned such sites was lucrative. Then came the global financial crisis, when investors embraced supposedly safer assets.
However, as corporations began to prosper under historically low interest rates, commercial property started to look more attractive and the returns over the past few years have been strong.
The IPD UK Annual Property Index had impressive returns of 13.1% in 2015 and 17.8% in 2014. Considering returns were -22.1% in 2008, the scale of recovery is appreciable.
Despite today’s more nervous markets, financial advisers and fund managers insist commercial property still has a part to play in the average portfolio, as it provides diversification and long-term returns.
However, it is important to distinguish so-called bricks-and-mortar funds that buy physical buildings from those that invest in the shares of property companies, said Justin Modray, director of Candid Financial Advice. ‘Physical property tends to be a lot steadier in terms of delivering reasonable growth and income. Property share funds tend to be more volatile but will potentially perform better when stock markets rise,’ he said.
There is also a huge difference between the best and worst performing funds in the IA Property sector. While the standout performers have risen more than 50% in the past three years, the worst have lost 10%, according to Morningstar data to 29 February.
Richard Levis, global property analyst at Aviva Investors, said the sector offered attractive characteristics for investors. ‘It’s a physical asset with an intrinsic value that may appeal to investors in search of tangible alternatives to other financial assets,’ he said.