According to IPD Index, British commercial property values rose 15.4 per cent to July 2010, their first full year increase since the financial crisis. Investors pumped £3 billion into property funds over that time.
The M&G Property Portfolio took around 40 per cent of the new money, according to Ed Protheroe, the fund’s portfolio analyst. He said: “The rally followed on from oversold levels, but petered out through Q2 as yield contractions slowed down.”
Property values over 3-yrs
Source: Financial Express Analytics
Recovery has not been uniform, prompting the development of a two tier market. Properties located in provincial and secondary locations offer double digit returns, but investors run a high risk of vacancies. The emphasis is on strong tenants who can pay their bills. Protheroe said “It is all about the income.”
A survey by commercial agent Colliers highlights the growing split. Retail vacancies in London remain low. So-called void rates are 3.5 times greater for the whole of the UK. Colliers said attracting new tenants is difficult and many properties now remain empty for longer.
Henderson UK Property fund co-manager Ainslie McLennan (pictured right) is acutely aware of the division. She said: “There is a complete divergence between good stock and absolute rubbish. A lot of the bad stuff has been mis-priced, with sellers still sticking with bullish valuations given to them by advisers some time ago.”
McLennan is wary of properties that may suffer if government jobs and budgets are slashed, particularly in the North East and North West.
“Cuts will hit provincial areas and eventually filter down to the high street,” she added.
Over the year to 6th September, property securities funds rose 18.68 per cent, but progress was choppy as equity market volatility rocked property share prices.
Stuart Martin, co-manager of the First State Global Properties Securities fund, said there is also a developing split in property related equities. A lack of bank financing is hindering weaker firms and holding back their stock prices.
Banks prefer companies with strong balance sheets and low levels of existing debt. Such firms can raise cash to refurbish existing buildings or buy new properties to boost income. Even if bank financing is short, shareholders are supporting strong companies by subscribing to new rights issues, said Martin.
As the sovereign crisis in Europe recedes, First State is bolstering Continental holdings at the expense of UK property shares that Martin thinks may have overrun. Allocations to Asia, Hong Kong, Brazil and Canada are also rising on the back of the commodity story.
Adviser AWD Chase de Vere is warning investors of challenging times ahead for all property funds. Spokesperson for the adviser Patrick Connolly said: “It is likely that any short to medium term capital gains have already been made and overall returns will be predominantly reliant on the rental income yield. This yield is currently only about 3 per cent per annum.”
With rental income falling, he thinks yields will come under further pressure. Property securities could suffer too as their income weakens.
Investors should not sell out as property remains a good diversifier against bonds and other shares. Connolly said: “We recommend that clients typically hold between 10 to 15 per cent of a portfolio in commercial property, and whilst we don’t believe weightings should be increased at this time, neither do we believe investors should be selling out.”
He likes the L&G UK Property Trust, Aviva Property Trust and SWIP Property, as well as the Henderson and M&G funds. AWD Chase de Veer does not recommend any global property securities funds due to short performance records and the inexperience of many international property fund managers.