Posted on: 02 Mar 2012 by James Farmer
Article from IFA Magazine
Commercial property woes are a drag on property funds, says Kam Patel
If you ever thought commercial property might be the last copper-bottomed refuge for a poor investor who was getting tired of watching his capital getting steadly eaten away by rising inflation and terrible cash returns, prepare to look away now. This isn’t going to be easy reading.
Yes, it’s taken us until now to reach this point, but we can’t avoid it any longer. The charmed existence that property funds have had over the last two years has finally succumbed to macro-economic inevitability. The ongoing upheaval of the banking sector, the poor state of the retail economy, and especially the dire shortage of lending at affordable rates, are taking their inevitable toll on the all-important commercial property sector.
The latest return to the gloom of 2007 and 2008 was highlighted in January by an industry survey by Lloyds Banking Group, the biggest lender to the property sector in the UK with £60bn of commercial property loans. The Lloyds study reveals that confidence in the key London commercial property market has hit a two-year low, with the net balance of respondents who expected the overall commercial property market to improve in the next six months falling sharply to just 2.8 – versus 32.2 at the end of August. And that’s the lowest reading since the index began in 2010.
Recovery ends
Unfortunately, as so often, our sorrows come not as single spies but in whole battalions. The Lloyds survey comes in the wake of other downbeat studies. IPD, the provider of real estate performance data to funds and investors, which publishes monthly snapshots of the sector, revealed in December that November 2011 amounted to the first time in 28 months that UK commercial property had recorded a negative – albeit slight – capital decline. All of which signalled the end of a sustained two-year recovery, it said.
The IPD report estimates the total return for the calendar year to date (11 months to November 2011) was 7.6%, with a capital return of just 1.3% over that period. It added that if returns continued at November levels for December, total return would amount to 8.1% and capital return would remain just positive for the year, at 1.2%. Capital growth on a rolling 12-month basis was 1.6%. But that’s well short of inflation, and it doesn’t even match what you could probably get from an instant-access savings account.
Commenting on the November findings, published in December, Malcolm Hunt, IPD UK and Ireland Client Services Director, said: “Poor economic growth forecasts, the ongoing Euro-zone crisis, high unemployment and inflation still hovering around 5% has left consumers and businesses, occupiers and owners alike feeling out of pocket. Deep uncertainty about the potential of the UK to avoid recession next year is now finding its way into property values.”
Let’s put that into perspective. November’s worrying performance followed a solid 27 months of growth in UK commercial property values, during which prices rose by 17.8%. But that good performance had been only a partial recovery from the hefty 44% fall between June 2007 and June 2009. There’s an awful lot of ground to make up.
Hunt added: “Outside of London, office value movements remained negative across all regions while the accumulation of stock for sale, and subsequent uncertainty in investor sentiment, has led to a slowdown in the City. “
West End still delivering
For the UK commercial property sector, and the many property funds that rely on its good health, the most worrying aspect of recent findings is the waning confidence in the London market, which accounts for the lion’s share of all overseas investment in the UK commercial property sector. Recent data from Real Capital Analytics shows that over 2011 institutions from the US, Asia, the Middle East and Europe spent £10.2bn on commercial property in London – nearly 80% of the total £13.2bn spent on the sector in the UK by overseas players.
The one real exception has been in West End offices, which are currently being seen as a safe haven to store wealth. “They’re continuing to go from strength to strength,” says Hunt. Elsewhere it simply isn’t the same story.
This uncertain outlook was reinforced in mid-January with the collapse of a deal to let one of the biggest future office schemes in the City itself. Anglo-French developer Hammerson announced that law firm CMS Cameron McKenna had pulled out of talks to pre-let a third of the 600,000 square feet £485 million Principal Place scheme in Shoreditch.
A recent report from Reuters, meanwhile, revealed that five central London skyscrapers being developed by firms including Land Securities and British Land have only signed one office pre-let deal between them.
Rollercoaster ride for funds
Clearly, property funds are a slightly different proposition from the hurly-burly of the property market itself. In principle, a well-run fund with a decent portfolio of properties ought to be insulated from the general troubles by loyal tenants who keep on paying their rents. But those too are under pressure. Data compiled by the Investment Management Association for IFA Magazine clearly illustrate the rollercoaster times that the funds have experienced over the last few years.
In 2005, it says, net retail sales of property funds across all wrappers totalled just £859 million. And in 2006 demand exploded to £3.6 billion. 2007 saw an overall net sales total of £2.07 billion, but that number concealed a bitter disappointment. Sales of £2.36 billion in the first half collapsed in the second half to a dramatic net outflow of £292 million as the financial crisis went into full swing. And the unmitigated dark year of 2008 saw net outflows of £390 million from the funds.
The recovery of 2009 and 2010 showed net retail sales of £1.81 billion and £1.84 billion for the two years respectively. But that recovery all but evaporated during 2011, with net sales of just £527 million for the 11 months to November – almost all of it in the first half. Performance during the five months to November was properly abysmal, with net retail sales of £24.8 million – falling to just £450,431 in October – as the economic woes and the eurozone crisis spooked investors.
Looking for the Positives
To be sure, the 2012 outlook for the commercial property sector is set to be challenging – but we shouldn’t underestimate the quality and resilience of UK commercial real estate, most especially London and the southeast, which boast a large, mature, transparent and liquid market that’s attractive to overseas players. The UK remains the fourth largest property investment market in the world. [Tony: worth a plug?]
Up until toward the end of 2011, UK commercial property continued to be one of the few asset classes to have provided reasonable positive returns over the year to date – despite (or perhaps because of) the ongoing eurozone problems. According to the recent figures from the Association of Investment Companies, property investment trust valuations have grown 23% over the past three years, compared with 18% for the average investment trust.
Results for the IPD’s UK Pooled Property Fund Index for the quarter to 30 September 2011, meanwhile, showed a three month return of 1.5% for all property funds – compared to minus 21% for property equities and minus 13.5% for the FTSE All Share Index. Not bad.
The IPD figures also show that annualised returns for all pooled property funds over one year to September 2011 came in at 8.6% and minus 2.3% over three years. Property equities delivered no return over one year and minus 10% over three years. Equities, meanwhile, provided minus 4.4% and plus 6% over the respective periods.
The commonest forms of property fund are currently unit trusts, open-ended investment company (OEICs) and Limited Partnerships. A unit trust, of course, is a collective investment scheme under which the property is held on trust for the participants. OEICs are similar to a unit trust in many ways but are structured as a corporate entity instead of a trust. Limited Partnerships, meanwhile, provide a tax transparent unregulated vehicle for collective property investment and are aimed institutional investors.
Given the scale of much commercial property investment and the specialist knowledge required, most private investors tap into the market via collective funds such as OEICs, unit trusts and tax-efficient real estate investment trusts (REITs).
Global funds deliver
There is no doubting that the UK commercial property market and allied funds have put on the good show in recovering from the financial crisis. But it is worth noting that the best performing property funds (unit trusts) currently, according to Citywire data, are global rather than UK offerings.
The top two positions over a year to December 2011 are held by Aviva Investors Asia Pacific Property, with a return of 16.2%, and by Huet Capital’s Salamanca Global Property, which made 7.4%. They are followed by UK focused funds, with London-focused Royal London Property (5.36%) in third place, followed by M&G Property Portfolio Sterling (3.96%). In fifth place is F&C UK Property (3.84%).
For the three years to December 2011, the top performer has been First State Global Securities (61.3%), with M&G Global Real Estate (59.2%) placed second; and HC FCM Salamanca Global (53.5%) coming in at third. Standard Life Global REIT is fourth (49.2%).
Focus on quality and diversity
With 2012 looking to be a challenging year for the London commercial property, investors, especially the risk averse, looking to access the sector need to focus on diversity and quality.
As the collapse of the Hammersmith deal helps to illustrate, the City’s prospects in particular are not great at present, and what’s more the loss of jobs in the financial sector tends to have direct impact on rental growth. It might therefore be prudent for an investor to consider funds that have good exposure outside London; within the capital, the focus can be expected to shift toward secure, prime property boasting long leases.
Article from IFA Magazine
