Poster child continues to prosper

Did anyone notice that last week the biggest ever investment trust launch took place? F&C Asset Management launched a commercial property investment trust that pulled in £975m.

Much of the money was simply a transfer of assets already managed by Friends Provident, but new money and new debt added up to £200m. Meanwhile, Britain’s billboards remain plastered with adverts from New Star promoting the benefits of its commercial property fund. New Star Property was the group’s best selling fund during 2004, while both Scottish Widows and Britannic have launched new funds in recent months.

Down at the bottom end of the market, buy-to-let investors who can no longer find opportunities in the residential market have switched to buying shops and commercial premises at auction, attracted by yields of 7-8%. The flood of cash into commercial property shows no signs of abating, despite the warning from Sir Andrew Large, deputy governor of the Bank of England, in December.

Last year was a record one for the London office market, with nearly 300 deals worth more than £9.5bn. Across Britain, commercial property sales hit a record of £42bn. Sir Andrew expressed concern that more than half of all corporate lending in the year to September was to the commercial property sector, where, he said, returns were falling.

“In the light of recent weak rental growth and high vacancy rates, it is unclear whether investors’ expectations of rental income will be met,” he said.

The return on commercial property last year was 19%, according to Investment Property Databank, the highest for 10 years. Meanwhile, property unit trusts have consistently produced gains of 10% a year or more over the past five years.

New Star Property is up 13.4% over the past year and 33.6% over three years. Norwich Property, now a staggering £1.3bn in size, has an even better record. It is up 17.5% over the last year and 38.9% over three years. But they are both eclipsed by the £580m TR Property investment trust, whose share price is ahead 38% over the last year and 123% over three years.

But is now too late to join the party? New Star clearly doesn’t think so. Its literature confidently states: “The commercial property market shows few signs of overheating.” Manager Roger Dossett expects yields to shift down another 80 basis points over the coming year, boosting capital values: “You’ve seen the equity and bond markets adjust in yield to reflect the lower inflation environment. But commercial property has been very slow to respond. It’s been catching up, but there’s still some way to go.”

At F&C, property director Michael Barrie is forecasting returns of 7-9% this year and 9% a year for the next five years. He also expects further yield compression and believes that rental growth will remain at or near 2004 levels.

Norwich Union is slightly less optimistic. Gerardine Davies, who manages the Norwich Property fund, says: “We expect higher prices and a weaker housing market to impact on sentiment. Returns over the next three years are likely to be nearer 7-8% per annum than the 13.5% per annum achieved over the past three years.”

The case for investing in commercial property rests on a number of factors. Rental returns have fallen, but are still about 6-6.5% a year, much higher than the yield on UK equities (3.2%), gilts (the 10-year gilt is on 4.8%) and cash (5.4% at best, in a notice account at Julian Hodge bank).

The flipside of falling yields has been rising capital values, but proponents say there are no signs of a bubble. While residential property values rose by 193% in the 10 years to 2004, commercial property rose by only 38%. Also, the economy has been growing quite strongly, stoking up demand by businesses for new space. Meanwhile, planning restraints limit the amount of supply (although the deputy prime minister, John Prescott, last week announced a partial relaxation of controls on out-of-town developments).

But you don’t need to scout round much to find the doomsayers – and many of the voices of gloom are property developers themselves. Development Securities is behind the giant Paddington Basin office development in London. It reported sparkling profit figures last week, but warned: “The continuing strong property investment market’€¦ has made acquiring stock at realistic prices increasingly challenging. Never before have we seen such a prolonged period of rising capital values, while the occupier market, the long-term driver of performance, remains subdued at best.”

Britain’s biggest industrial landlord, Brixton, also reported strong figures last week – and also issued a warning. Chief executive Tim Wheeler said: “I think we have to be generally fairly cautious. We have all seen bubbles burst. Equivalent yields in property have never been as low.”

It doesn’t seem to be too much of a worry for New Star’s Dossett. Indeed, he agrees that office development in the City and Docklands areas of London is highly risky – and despite the fact that the billboard adverts feature high-rise office blocks, his fund is avoiding the area completely.

Dossett took over the fund in October last year, but has not had a clear-out of the portfolio. He inherited a fund that had done well out of investments in retail premises (it was previously managed by shopping centre specialists Capital & Counties) and is only now re-orientating it towards offices.

“Retail has had a good run, and if you look at rentals, we are still seeing growth coming through. But I’m now concerned about a slowdown in consumer spending. When new money comes in, we are shifting towards offices, largely in the West End and the home counties.”

His single largest holding is Park View, an office on the Great West Road in West London, while other major units are in Wimbledon, Birmingham and Gloucester: “Park View is let to one of the leading engineers in the oil and energy sector. We bought it on a yield of 6.8% at the end of last year.”

He likes a lot of the London suburban markets, such as Guildford, Uxbridge and Chiswick. The risks, he believes, are in speculative oversupply in the City and Docklands, but so long as investors steer clear of that area, 2005 will be another good year for property.

PATRICK COLLINSON
The Guardian Personal Finance Editor