In the investment world, property funds took one of the biggest hits after the EU referendum vote went against general expectations. Following strong growth for the previous three years the first few months of 2016 saw an increasing flow of money out of property. This fear was then exacerbated by the Brexit result. As a result we saw significant outflows from some funds, which even forced a number of them to suspend trading.
But just over one year on from the vote how has the investment landscape for property changed?
Most direct property managers have been surprised at how well the market has held up post the Brexit vote. If you look back to the weeks after June 2016 there was a lot of money leaving the sector over fears of a significant write down in UK commercial property values and that has not happened.
In fact, a weaker pound post the Brexit result has, if anything encouraged more overseas institutional money into the space, looking for opportunities. Recent conversations with UK managers back this up and there remains money chasing selected assets. Year to date 2017 returns have been ahead of the start of year consensus, if not particularly exciting.
We see managers perhaps being more defensive, focusing on assets that should be easier to sell if necessary and avoiding the asset management, added value type of properties. Essentially back to property basics; focusing on quality income with less added value from capital appreciation.
Clearly the panic in June 2016 has led to higher cash levels – on average funds have between 20-25% in cash at the moment and some have more. It’s a tough call for managers at the moment as they want to get that cash invested to avoid cash drag, in quite a thin market, but they also have to tread a fine line between maintaining sufficient liquidity to meet outflows should we see another panic.
Managers will definitely not want to gate so are likely to maintain higher cash levels than we saw a year ago for the time being, with perhaps 15% being a target or low level compared to around 10% previously. Clearly this level of cash is going to be a drag on performance in a rising market so as investors we need to adjust our expectations.
What are the concerns for property?
The concern is that despite a lot of press headlines and debate during the last (mini) crisis about the risks of offering daily liquidity in an illiquid asset class nothing has fundamentally changed in the structure of the open ended funds.
So if the previous panic was not a one off and some sort of other major news event or continued UK political uncertainty causes investors to once again rush to withdraw cash from the sector, this would not be a healthy situation to be in. However, hopefully higher cash levels and investors’ experiences from last time will dampen these outflows.
Remember that post Brexit, property funds quickly regained the vast majority of their marked down prices and if you bought at that time while others were selling you will have done rather well. Having higher cash levels, and lower returns in a rising market, is going to have to be the new accepted face of investing in the asset class. If you are not prepared to accept this then perhaps it’s best to stay away or invest in a more liquid form of property such as REITs and take the volatility that goes with it.
Should investors steer clear of the sector?
Investors should be wary of shunning property and should think carefully about the role it plays within their portfolios. We believe it can still be an attractive income play in a low growth environment.
Property remains a diversifying exposure, in particular to equities, with a currently attractive level of income and lower volatility. If you are prepared to invest for the long term then it remains a useful component of a diversified multi-asset portfolio and when others are looking to get out you need to be prepared to sit back and watch and take the income or accept that you may have to wait for your money or accept a lower valuation if you can’t.
If you are concerned about the outlook for the core commercial sector then you could consider specialist property that can provide an alternative route into the asset class. There are a variety of different property types such as industrial warehouses, student accommodation, and health care, which all offer different structural drivers of return with a reasonable income.
Nathan Sweeney is senior investment manager at Architas