Price falls prompt a new breed of bargain hunters

Sharp falls in the price of flats, malls and offices – whether in Cape Town, Hong Kong or South Kensington – are beginning to present an opportunity for risk-taking investors – and property fund managers are already seizing the moment to unveil new products.

The latest fund launches vary by type and location and come as property managers and real estate investment trusts (Reits) are still being hit by the decline in the value of their assets, weak balance sheets and high gearing levels.

Stanlib, Standard Bank’s asset management arm, is preparing to open a Dublin-domiciled global emerging property fund, which will invest in a collection of Reits and listed developers. Gulf Finance, the Islamic group, is to launch a £50m UK commercial property fund. And collective investment schemes targeting the UK’s residential and commercial markets are being set up by boutique advisers.

“We’re seeing an upswing in interest for new property funds looking to take advantage of opportunities arising from distressed developers forced to dispose of property portfolios quickly at deep discounts to current valuations,” reports James Sullivan, managing director with PILinvests, which helps to set up funds. “Specialist property managers are positioning themselves to make the kill. These bulk discounts are likely to exceed any further price corrections and are resulting in high initial rental yields and good income for investors.”

A report out this month from Standard & Poor’s reveals that property stocks around the globe slid 19.8 per cent in the first quarter, dashing hopes that the market is nearing its bottom. In the UK, conditions have been so poor that a number of property companies have been forced to raise equity through rights issues and forced sales to cover banking agreements.

The picture may worsen further if property prices and occupancy rates fall and rents soften even more. However, the case for investment is growing more compelling as the gap between the cost of financing and property yields widens. For example, swap rates are now around 2.92 per cent and average property yields are 7.5 per cent.

“People are going to earn more of their return from income not capital appreciation,” says Philip Stott, a partner with Caisson Investment Management. “And if you invest in the next year or so, you’re going to be confident that you haven’t overpaid. These sorts of rates haven’t been around since the 1950s and yields haven’t started to contract yet.”

Caisson is one of a new breed of “embryonic” property investment management companies seeking investors. So it does not face the “legacy problems” of overleveraged companies running older funds. Its managers began conducting due diligence late last year when there was a realisation that the adjustment in property values was taking place at a rapid pace, says Liam Bailey, head of residential research at Knight Frank.

“Anecdotally, they felt that there was a window of six months – leading up to mid-2009 – for them to complete their business plans, fund structuring and to begin to identify stock,” Bailey says.

The London residential property market is being picked over largely by UK-based private equity and pension fund investors, as well as a handful of Middle Eastern and US companies. Private equity groups and other companies are said to be rolling out more “thematic”, or niche, funds focused on a particular sector.

CBS Property, for example, was set up by Poynton York Sipp to invest in high-yield residential rental flats. Caisson is looking to launch a “straight” commercial property fund and is also considering specialist sector funds.

Meanwhile, Myron Mahendra, fund management director with Chancerygate Asset Management, says: “The sort of fund we are launching is conservative. We are looking to target assets of high quality – prime assets with long leases.” Chancerygate is trying to launch a £10m high-yielding property fund focused on the UK. “We think the timing is right. If we strike at the right price then it’s worthwhile.”

The fund’s gearing, at 50 per cent, will be modest and it is seeking commercial investments such as DIY stores. So far, it has amassed £3m-£3.5m of its target of £10m in assets.

“Everyone’s nervous, but provided the assets can be secured at a discount to allow for any potential fall in value, we’re quite confident some of these funds could get off the ground,” says Sullivan of PILinvests.

“The million dollar question is whether these funds will be able to raise the equity. Just offering big returns, isn’t going to cut it anymore. You have to have a solid track record, a solid asset manager and income of more than 5 per cent to be competitive.”

Fearful of rising void rates and the stability of leasing covenants, James Butterfill, an investment strategist with HSBC Private Bank, suggests buying into existing funds such as Morgan Stanley’s Sicav European property fund or TR Property Investment Trust. Another recommendation is Standard Life’s property income trust, which has large cash reserves and conservative management.

A number of managers remain optimistic about the outlook for the property market. Besides, as Luca Giangolini, head of corporate finance with Cushman & Wakefield, the property company, says: “If you have a good tenant on the lease, it doesn’t matter if rental values fall – he’ll stay on for the duration of the lease.”