Choosing a fund with a seasoned active manager is the best route into property for most retail investors
Commercial property is an interesting asset class, and often popular with investors, although not without risks. On the positive side, it can be an income generator, a diversifier, an inflation hedge (although by no means a perfect one) and improves an investor’s efficient frontier.
In reality, I suspect that investors are most concerned, particularly at present, with the first of these potential benefits, but we should not let that detract from the fact that the others are rather handy too.
Unfortunately, there are also some quite big disadvantages associated with investing in commercial property, including the cost, large lot sizes and the distinct lack of liquidity (particularly when you actually need it).
Fortunately for retail investors, some of the cons traditionally associated with commercial property can be sidestepped, at least to some extent, by using pooled vehicles. These allow investors access to an asset class that would otherwise be out of reach owing to the large lot sizes (usually above £10m per transaction).
They also provide a far better degree of liquidity, although investors should be aware that even this can dry up in tough times if everyone wants their money back at once.
On the downside, despite the economies of scale that some of the large funds enjoy, investing in commercial property is still an expensive business, and the annual management charge levied on pooled funds only adds to the cost. In addition, the large cash balances that managers are forced to hold so that they can provide daily liquidity can drag on returns at times.
However, having an experienced active manager running a fund should add value for investors, and this is still the best route into commercial property for most.
Indeed, UK commercial property funds have enjoyed a resurgence in popularity over the past few years. With equity markets volatile, bond yields remaining low and nigh on zero interest available from cash deposits, it seems that the sector’s attractive level of yield may be drawing many investors back into property.
Despite a fall in yields this year following the rally in the commercial property market, they still compare favourably to those available on cash, government bonds and higher-quality corporates. This, combined with the sector’s natural diversification benefits, helps to explain the strong inflows into the asset class.
Moreover, it is not just UK retail investors that have been showing an interest in the market. Foreign buyers have become an increasingly important presence, and sovereign wealth funds in particular now
have increasing influence, especially in London.
This has heightened pricing pressure in the market and presents something of a problem for the more valuation-sensitive fund managers, as many sovereign wealth players are prepared to pay a valuation premium for prime London locations.
Given the costs and pitfalls inherent in investing in the commercial property market, we prefer to use experienced managers who can navigate the various obstacles, particularly in difficult market conditions. One of our favoured options in this area is the Aviva Investors Property Trust.
Aviva has a strong heritage in managing property assets and this fund has one of the longest performance records in the sector. It is run by Philip Nell, who focuses on well-located, high-quality assets to form a core for the portfolio made up of stable, income-generating properties.
About 25 per cent of the fund is invested in assets that have rents linked to the Retail Prices Index. These are complemented by properties where value can be added through active management, such as refurbishments and the early renewal of leases to ensure high occupancy rates.
Investors who like the asset class for its income-generating capacity may be interested in the recently launched Kames Property Income fund. This fund focuses on providing a reliable income stream. It does not have a hard income objective, targeting a yield 0.75 per cent higher than that of its peers in the sector, but the managers calculate this will equate to a yield in the region of 6 per cent for the foreseeable future.
The fund was launched only in March, so it is not yet appropriate to comment on whether or not it has met or can meet its objective, but we believe this is an interesting proposition, run by experienced investors, and is one to watch for the future.
Victoria Hasler, senior investment research analyst, Square Mile Research