Climbing back up the property ladder

Property has been one of the worst places to be in the investment world for the past five years, but Guy Morrell, the manager of HSBC Open Global Property fund, says the sector is improving.

The Shard is nearing completion. The first steel beams of the Cheese Grater, British Land’s new 737ft skyscraper, are reaching upwards. Even better news – much of it is already pre-let. Is London’s new skyline evidence that the commercial property market, one of the first victims of the financial crisis, is now ripe for recovery?

Don’t count on it just yet. Property has been one of the worst places to be in the investment world since 2007. Pull up a ranking of all IMA sectors for the past five years, and you’ll find that property is rock bottom, 36 out of 36. The average property fund is still down 24.5% over five years, compared with the 8% gain in the typical All Companies sector fund, and 60% for technology or China funds. 2011 was another poor year, showing a 0.8% fall.

British Land itself suffered a near-death experience, as its shares plummeted from 1300p in April 2007 to just 300p two years later. In the most extreme case, Invesco’s Property Income Trust lost 99% of its value. Many fund advisers will remember having to explain to clients that they could no longer access their money held in the illiquid property funds of the life and pension companies.

But from their recessionary lows, commercial property values in London have climbed back 35%. However, it has to be noted that in recent months confidence has dipped again. The latest IPD UK monthly index said that values in London fell 0.2% in January with total returns at their lowest since June 2009. Rents on retail across the UK, including London, also remain severely under pressure. (Collinson continues below)

But the picture in America is brighter. The latest National Association of Realtors report on commercial property found vacancy rates falling and rents rising, particularly in Washington and New York. Even the bombed-out retail sector is experiencing a bounce, with some areas, such as San Francisco, running with just 5% vacancy levels.

So is it time to head back into commercial property investment? Guy Morrell, the manager of HSBC Open Global Property fund, thinks so. But launching the fund in November 2007 was probably not the best timing. By early 2009, the fund had lost nearly 30% of its value, although to be fair to Morrell, the index was down a lot more. Since then, the market has been a lot kinder, and Morrell’s stockpicking has helped boost returns. Over three years it is up 54.3%, compared with the 33% gain of the average property fund, although even this level of outperformance puts it just outside first quartile.

HSBC Open Global Property is a fund-of-funds which mixes both direct property and property shares across all parts of the globe, so it’s unlikely to ever be at the absolute top of the table. Currently that position is held by Aviva’s Asia Pacific property fund, which is up 26% over the past year.

At launch in 2007, Morrell was extremely cautious about British property, which was the right call, but given the global situation, there were few places to hide, other than cash.

“Staying out of the UK at launch was definitely helpful,” says Morrell. “At one stage we were 30% in cash, as we had a high level of confidence that the UK market was going to fall in value.” But the UK took the pain early and quickly. Valuers here marked down prices more aggressively than almost anywhere else in the world, which at least created grounds for a later recovery – one that in Europe is still some way from happening, says Morrell.

Currently the fund is 53% invested in funds holding property shares, and 39% in funds holding direct property. Of the property share holdings, 26% are in America, 19% in Asia, 9% in Britain and just 4% in Europe. Overall, the fund has a much higher allocation to the UK, largely the result of its investments in direct property funds.

“Over the last 12 months, the US property market has performed more strongly than almost anywhere else in the world,” says Morrell. Much of it has been driven by income-hungry investors chasing the yields offered by real estate investment trusts, many of which are now trading at a premium to net asset value. “We’ve slightly moderated our allocation to US Reits, which do not offer tremendous value at the moment,” says Morrell.

Asian property funds are more attractive, with most standing at discounts to net asset value. “Obviously there has been the concern about a hard landing in China, but the market has discounted a lot of bad news and sentiment has improved recently.” Discounts on Asia-Pacific property funds have narrowed from 15%-55% in September to 10%-40% in January, driving returns in the region.

”Over the last 12 months, the US property market has performed more strongly than almost anywhere else in the world”

Although his European allocation is very low, so is the continent’s 15% weighting in the global index. “A lot of European property is not in a securitised form for investment. Of what’s there, we don’t like it because we don’t think the market has fully priced in the problems in Europe. The data on Europe is also opaque, and much less transparent than in the UK.”

There are 12 funds in the portfolio, with a range of 8-14 since launch. His single biggest holding is Henderson UK Property, which he says gives “a good, solid exposure to the UK property market from a very experienced team.” An HSBC fund, MultiAlpha Global, is next but in reality it’s a fund which allows him to access sub-funds from independent managers in America and Asia Pacific. “There’s also absolutely no double-charging on fees, either,” he adds.

Two Schroder funds, Asia Pacific and Global Property Securities, are also near the top of his list. More recently, Morrell has been buying into HICL, the HSBC infrastructure vehicle, to obtain a more diversified property portfolio that includes schools and hospitals.

After a poor 2011, and with the sector bottom of the five-year tables, there’s obviously an argument for investing on a reversion-to-mean basis. Globally, commercial property remains 25% below its all-time peak in February 2007, so there’s still a lot of room for recovery.

Patrick Collinson is The Guardian’s personal finance editor.