Investors chase commercial property yields

Investors searching for income are looking again at commercial property as returns from cash and bonds continue to fall. But opinion is divided over whether now is the right time to get back into bricks and mortar.

Commercial property bulls say returns on investment in the sector are strong, particularly in the context of the low interest rate environment. The sector yields about 6 per cent, according to the IPD All Property Quarterly Index.

But it is proving a tough sell for investors who had money tied up in it a few years ago. Commercial property was a big casualty of the credit crunch, and a string of funds including Standard Life, Aviva, Axa and Scottish Equitable were forced to close in 2008 as investors flocked to withdraw their money.

Property prices are more than 35 per cent lower than in 2007, though capital values have recovered somewhat since 2009.

Advisers say investors in the sector are focusing on steady yields rather than capital growth, highlighting a major shift in investment objectives.

“Before the downturn, the main objective was typically capital growth,” says Adrian Lowcock, senior investment adviser at Bestinvest. “Now it is more about the income that can be generated from property. There is more emphasis on retaining tenants and therefore generating a stable, guaranteed income stream.”

Rob Martin, director of research at Legal & General Property, also points out that holding commercial property within a portfolio can help to smooth out volatility in the stock market, as the two asset classes are not highly correlated.

Funds in the sector can also offer a diverse spread of investments. “There has been a rise in diversification among UK funds,” says Phil Tily, managing director of UK and Ireland at IPD. “Many funds now invest in alternative property asset classes – hotels, residential, leisure, healthcare and infrastructure – which in many cases have boosted performance and provided diversification.”

Ainslie McLennan, fund manager in the property team at Henderson Global Investors, says there is good value in these areas. Other commercial property fund managers, including Aviva, agree they are looking at sectors within commercial property that have not traditionally featured within their remit.

Michael Barrie, director of balanced funds at Legal & General Property, says one advantage of UK commercial property is that it has regular, index-linked rent reviews to stay in line with rising prices. This provides investors with some form of inflation-proofing.

For those brave enough to dip their toes into the sector, the most straightforward route into commercial property is through a property fund, which invests in either the shares of property and real estate companies or a portfolio of bricks and mortar properties managed by the fund manager.

One of the highest yielding mutual funds in this sector, according to Lowcock, is the Schroder Global Property Income Maximiser, which currently yields 7.2 per cent. Other funds recommended by advisers include the Henderson UK Property unit trust, which yields 4.8 per cent, and the Aviva Asia Pacific Property fund and Legal & General’s Property unit trust, both yielding 3 per cent.

Patrick Connolly, certified financial planner at AWD Chase de Vere recommends the Henderson UK Property fund, Ignis UK Property and M&G Property Portfolio fund. However, he advises clients to hold only between 5 and 12 per cent of their portfolios in the sector, as “property investments face challenging times”.

Returns on property unit trusts have also been strong over the past three years, says Lipper. M&G Global Real Estate Securities returned 76 per cent in the three years to June 30, while First State Global Property Securities returned 95 per cent over the same period, said the data provider.

Another way into the sector is through property investment trusts – which are listed on the stock market and invest in property shares. Many of these investment trusts have delivered even more impressive returns than unit trusts over the past three years, though some have suffered significant losses.

According to Lipper, Ignis UK Commercial Property Trust, yielding 7.44 per cent, returned 26 per cent in the past three years, while the F&C Commercial Property Trust is up 64 per cent, with a yield of 5.76 per cent.

Lowcock likes Picton Property Income, yielding about 11 per cent, and Schroder Real Estate Investment Trust, with a 9.5 per cent yield.

Investors can also buy into real estate investment trusts (Reits) as a means of holding commercial property in their portfolios. Mick Gilligan, at Killik, the broker likes the London & Stamford Real Estate investment trust, with a yield of 6.85 per cent. It is trading on an 8 per cent discount to its net asset value.