Isa ideas: Commercial property – the funds to invest in and why

5th March 2014

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Should you consider commercial property for your Isa? Investment journalist Cherry Reynard looks at the sector and asks advisers for their fund picks?

Commercial property has historically been a steady source of predictable income for investors. Investing in properties that are let to businesses may not have produced the exciting capital gains seen in the residential sector, but it has generated good income and stable capital returns. The exception was a brief period prior to the credit crisis, when commercial property became ‘hot’ and investors in the asset class experienced a boom and bust that turned many off the sector. However, since then it has been back to business as usual for commercial property and investors have slowly started to return.

Range of fund strategies within sector?

There are two main strategies within the commercial property sector. Around half the funds in the sector invest in property shares. These are often structured as Real Estate Investment Companies (Reits). Reits attract certain tax advantages in exchange for distributing 90% of their income to investors. Property companies around the world will use the Reits structure. Funds investing in property shares will tend to be more focused on capital growth rather than income, and will tend to have greater diversity: Some will look outside the UK, for example, either to specialist markets such as Europe or Asia, or will take a global remit.

The other funds in the sector invest directly in commercial property. They will buy and sell buildings, are responsible for their upkeep and maintenance and will collect the rental payments. In practice, they will outsource some of the day-to-day management to specialists. These funds will tend to be focused on generating a long-term, dependable income stream for investors. They also tend to be less liquid, because property can take time to buy and sell, and should therefore be considered long-term (5 years+) holdings. Different funds will focus on different parts of the market – some may specialise in high street retail, for example, or office buildings, though in practice most will aim to have a diversity of properties across the market.

Recent performance

Improving economic growth has seen the property sector slowly catch up with some of the other IMA sectors. Over the past five years, the average fund in the property sector has grown by 68.6% (to 28th February). This compares to average growth from the UK Sterling Corporate bond sector of 56.8%, from the UK All Companies sector of 134.7%.

Property share funds have outperformed direct property funds over the past five years. As the stock market tends to anticipate economic recovery ahead of time, they saw strong gains in 2012/13, but direct property funds have started to catch up over the past year. The top performing funds have all tended to have a global focus with the Henderson Horizon Global Property Equities fund sitting top of the table over three and five years.

The income available on the funds within the sector varies from 0 to almost 7% with the direct property funds generally paying 3-4.5%. Although property is seen an income-generative asset class investors should not assume that every fund will pay an income.

When does it perform well/badly?

The commercial property sector will tend to produce stronger returns in a climate of improving economic growth. As an economy expands, businesses do better and commercial property managers can raise rates. In this way, commercial property can also protect against inflation. Funds that are focused on the higher quality (prime) end of the market will tend to be less vulnerable to weakening economic growth, but may not produce as strong capital growth in a more buoyant climate.

How much of a portfolio for low/mid/high risk investor?

Commercial property funds can provide good portfolio diversification in a portfolio otherwise focused on stock and bond markets. It is a means to diversify an income stream and create greater stability.

Popular funds

Top 10 by performance (5 year – %) – Property sector

Henderson Horizon Global Property Equities – 182.1

Aberdeen Property Share – 179.7

Standard Life Investments Global REIT – 173.3

Principal Global Property Securities Hedge – 169.7

Premier Pan European Property -161.8

JPM Global Property Securities – 152.4

Henderson Horizon Pan European Property Equities – 151.7

Henderson Horizon Asia Pacific Property Equities – 151.5

First State Global Property Securities – 146.7

Fidelity Global Property – 143.7

Questions for investors to ask themselves

Do I want to generate an income?

Do I want a manager who invests in bricks and mortar, or property shares?

Do I want a manager who invests globally or just in the UK?

Am I prepared to tie my money up for 5 years or more?

Adviser comments and some fund picks

Jason Hollands, Managing Director – Business Development & Communications, Bestinvest

“Property is back on the radar of investors again, as capital values have recovered in line with economy since last summer. UK commercial property returns are expected to be in the 10-12% range this year but lower as we move into 2015 when rate rises are anticipated, impacting re-financings.  That makes us overall neutral on the asset class.

“While normally we prefer closed end structures for illiquid assets like physical property, the leading trusts are trading at hefty premium to NAV, reflecting strong demand for income generating investments. For example: F&C Commercial Property Trust is trading at +15% premium, Schroder Real Estate Investment Trust a +15% premium and the less London/SE orientated UK Commercial Property Trust a 10% premium.

“Our favoured open ended fund is Henderson UK Property, yielding 3.9%. The portfolio consists of 59 quality properties, negligible voids and long leases. Around three-quarters of the portfolio is invested in the South East. It also has an above average allocation to higher quality tenants. It has around 20% in cash which gives it flexibility to invest quickly and to meet redemption requests, but could also be a drag on performance and dividends.”

Patrick Connolly, financial planner, Chase de Vere

“Commercial property can provide consistent long-term returns and can act as a good diversifier in a portfolio, providing some protection from stock market falls. This means that most investors should look at holding property in their portfolios.

“It is important to understand where a property fund invests. 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. We only recommend commercial property funds which invest in ‘bricks and mortar’ property, as these have far less correlation to the stock market and are less volatile than investing in property shares.

“Property funds we recommend include: Ignis UK Property, L&G UK Property Trust.”

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