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Property sector

Property sector

Property is a deceptively diverse asset class but can broadly be split into two: residential and commercial.
Heather Ferguson

Heather Ferguson - Investment Analyst
01 August 2017

Property is a deceptively diverse asset class but can broadly be split into two: residential and commercial. There are very few funds which focus on residential property. Those seeking exposure to this area tend to do so through their home; a buy-to-let investment; or individual property shares.

Within the commercial property sector, where fund managers tend to focus, funds invest in either physical property (bricks and mortar) or property shares. Physical commercial property can be split into three: retail, office and industrial.

The fortunes of commercial property funds are heavily tied to the health of the economy. When economic growth is strong, demand rises which pushes up rents and capital values, as well as encouraging more construction. During a slowdown the opposite occurs.

Commercial property is primarily an income story. Since it launched in December 1986, most of the return on the UK’s main benchmark of commercial property performance, the IPD All Properties Monthly Index, has come in the form of income. We expect this trend to continue.

  1. Physical property
    • Residental
      • Buy-to-let
    • Commercial
      • Property fund
        • Retail
        • Industrial
        • Office
  2. Alternative property exposure
    • Residental
      • Individual property shares
    • Commercial
      • Property Fund
      • Investment Trust/REIT

Our view on the Property sector

Unit trusts investing in physical property:

Although popular with investors, open-ended funds are not the most effective way to access this area of the property market, in our view, for the following reasons:

  • Commercial property is not easily bought and sold and property funds tend to receive large inflows when property prices are buoyant. As it can take time to identify a suitable investment and then several months to finalise the purchase, the manager can often end up holding large levels of cash – missing the gains in the market. The same situation occurs in reverse when the property market is performing poorly. If investors’ request a return of their capital, the manager could be forced to sell properties to meet the redemptions. In falling markets it is often only possible to find buyers for the most attractive properties, leaving the most unattractive ones in the fund for the remaining investors. These factors can prove detrimental to the fund’s performance and mean returns are not solely down to the skill of the fund manager.
  • The fund manager is able to halt redemptions in the fund, which means investors are unable to sell their investment.
  • Fund managers have the ability to apply adjustments to the pricing of their funds. In the recent past, these adjustments have wiped around 20% off the value of some funds overnight. As investors never know the price they will receive in advance of a fund sale, this could be costly.
  • The costs involved in buying and selling property tend to be very high. Once these costs have been met and the fund manager’s fee applied, there is little yield left for the investor. If the investment is held outside of an ISA or SIPP, there is also tax to pay on the income received.

Unit trusts investing in the shares of property companies:

This works in much the same way as any fund investing in company shares and the value of the fund is directly correlated with the value of the underlying holdings. A large proportion of these funds tend to be invested in Real Estate Investment Trusts (REITs). A benefit to investing in this way is that the fund is managed by an expert who selects which property related companies to invest in on your behalf.

Closed-ended property funds such as REITs are not affected by many of the issues suffered by open ended funds. Unlike a fund manager who needs to create or cancel units depending on whether they have a greater number of investors buying or selling, a REIT issues a fixed number of shares. This leaves the manager free to invest the fund’s capital as they see fit, without having to ensure they have sufficient cash to meet redemptions.

The issue for the investor is that the value of their investment is largely dependent on supply and demand for the shares in the trust. While there will be a price that investors can trade at, even in a tough market environment, it may be at a discount to the underlying intrinsic property value. In return for this ability to trade in all market conditions, the investor needs to accept greater volatility in the price of their investment. In addition, investment trusts are able to borrow money, which can improve returns when markets are rising but amplifies losses in falling markets, so is a higher-risk strategy.

Investment notes

Please remember past performance is not a guide to future returns. Where no data is shown, figures are not available. This information is provided to help you choose your own investments, remember they can fall as well as rise in value so you may not get back the original amount invested.

Office: includes business parks and office building

Having previously been one of the best performing property sub-sectors, the office sector has been the worst performing area over the past year. The London market has driven the sector’s strong long-term performance but was hardest hit by Brexit with rental growth expectations falling sharply following the vote. Rents are still expected to fall across the capital over the coming year, placing continued pressure on the sector. Meanwhile rental growth across the UK is expected to be modest for offices in prime locations, but could slow in secondary locations

Retail: includes shops, shopping centres and retail parks

With fewer people hitting the high street, demand for retail property has fallen, putting downward pressure on rents. The retail sector has been the worst performing sub-sector over the past 3 and 5 years. Bucking the trend are the famous high streets in the largest cities, where prestige comes before price. In these areas, a large number of shops want to be in a small number of places and so marginal rental growth is expected in these areas. Away from these high streets rents are stagnant, and in many areas are falling.

Industrial: includes factories, distribution warehouses and industrial estates

While the retail and office sectors struggled in the wake of Brexit, the industrial sector has remained relatively robust and is the best performing sub-sector over the past 1, 3 and 5 years. Supply of leasable space is more or less unchanged in the office sector and has marginally increased in the retail sector, while industrial availability continued to decline, supporting rental prices. The longer term prospects for this sub-sector remain strong as it benefits from the growth of online consumption. Distribution warehouses are becoming increasingly important for e-commerce and retailers are investing in cutting-edge facilities to help cope with demand. Regional dispersions for the industrial sector are less pronounced. However, locations within easy access of ports or the M25 are often well sought after.

Past performance is not a guide to future returns.

Investment notes

Please remember past performance is not a guide to future returns. Where no data is shown, figures are not available. This information is provided to help you choose your own investments, remember they can fall as well as rise in value so you may not get back the original amount invested.

Property fund reviews

We undertake a comprehensive review of every sector. Here we provide comments on a selection of funds of interest following our most recent Property sector review. They are provided for your interest but are not a guide to how you should invest. If you are unsure of the suitability of an investment for your circumstances seek personal advice. Comments are correct as at August 2017. Remember all investments can fall as well as rise in value so investors could get back less than they invest. Past performance is not a guide to the future.

There is a tiered charge to hold funds in the Vantage Service with a maximum of 0.45% p.a. - view our charges.

Source for performance figures: Financial Express

The fund invests predominately in physical property with a bias to the South East.

The fund is biased to the South East of the UK as the manager feels this is where demand is highest, thereby ensuring the vacancy rate (periods when a property does not have a tenant) within the fund remains low. She has been successful in investing in properties that are infrequently empty and the vacancy rate of the fund is lower than the Investment Property Databank (IPD) average. The fund has a relatively high proportion of ‘alternative’ properties compared with the index. This includes student property and hotels.

Performance has tended to be in line with the IA Property sector average; however, the fund has underperformed this benchmark over the past five years due to two sharp price falls surrounding the UK’s Brexit vote last year. Although performance over the past year has been good, the fund has yet to recover these losses.

The fund invests in UK commercial property with a focus on retail and office buildings

The fund invests in a range of properties including offices, high street shops, shopping centres, out-of-town retail parks, distribution warehouses and leisure facilities. It can also hold some property company shares and cash.

A large number of new office developments are currently coming to market, just as demand for office space is falling. The manager is therefore cautious in his short-term outlook for the sub-sector. Elsewhere, lower levels of disposable income among UK consumers will place strain on the retail sector, although the manager expects high-quality retail space in core locations to continue to perform well.

Andrew Hook assumed responsibility for the fund in March 2015. Over his tenure, the fund has fallen in value and underperformed the IA Property sector, due primarily to the fund’s poor performance following the UK’s decision to leave the European Union in June last year.

The fund invests in UK commercial property with a focus on retail and office buildings.

The fund invests in a range of properties including offices, high street shops, shopping centres, out-of-town retail parks, distribution warehouses and leisure facilities. It can also hold some property company shares and cash.

A large number of new office developments are currently coming to market, just as demand for office space is falling. The manager is therefore cautious in his short-term outlook for the sub-sector. Elsewhere, lower levels of disposable income among UK consumers will place strain on the retail sector, although the manager expects high-quality retail space in core locations to continue to perform well.

Andrew Hook assumed responsibility for the fund in March 2015. Over his tenure, the fund has fallen in value and underperformed the IA Property sector, due primarily to the fund’s poor performance following the UK’s decision to leave the European Union in June last year.

The fund invests in the shares of listed property companies, and companies deriving a significant proportion of their assets or returns from property.

Most funds in the IA Property sector focus on physical property, which tends to appreciate at a slower rate than property shares but is less volatile. The Aberdeen Property Share Fund is managed by the Aberdeen pan-European equity team and holds no direct property exposure. The fund is predominantly invested in the UK (around 80%) with the remainder invested across Europe, mainly in Germany, France and Sweden.

The UK commercial property market has stabilised following volatility in the wake of the Brexit vote, although property-sector equities fell in May amid political uncertainty caused by the UK’s general election. Over the long term the fund’s performance has generally been in line with the FTSE 350 Real Estate Index; however, the fund fell to a lesser extent than the index following the Brexit vote, which has aided more recent returns.

Grainger, the leading listed owner of private-rented-sector (or PRS) housing in the UK, is a recent addition to the portfolio. To fund this purchase, the fund’s investments in Hammerson and Land Securities were reduced.

The fund invests in UK commercial property with a focus on the retail sector.

The retail sector has been resilient in the face of Brexit although the manager expects rental growth to be muted moving forwards. Inflation and low wage growth could cause retail sales to fall, placing pressure on the sector. The manager favours those in locations with an affluent population or high tourism. She tends to avoid the traditional high street and prefers out-of-town shopping centres. Exposure to the retail sector has reduced over the past year.

The manager’s pessimistic view of the office sector has softened marginally over the past year as she feels Brexit will have a lesser impact on the sector than first thought. However, she continues to feel London will be the worst affected.

Performance has tended to be in line with the IA Property sector average; however, the fund has underperformed this benchmark due in part to sharp price falls surrounding the UK’s Brexit vote last year. Although performance over the past year has been positive, the fund has yet to recover these losses.

The fund invests in UK commercial property with a focus on London and the South East.

Outside the three main sectors (industrial, retail and offices) the fund also has exposure to nursing homes/hospitals, student accommodation and hotels. Alongside physical property, the fund can hold a blend of cash, property derivatives, bonds, and real estate investment trusts (REITs). Around 20% of the fund is currently held in cash.

Although performance has since improved, the fund is yet to recover losses made in the aftermath of the UK’s decision to leave the European Union. The fund heavily underperformed the IA Property sector over this time. Recent gains can be attributed to the fund’s investment in well-situated industrial buildings. These properties have performed well as demand for online retail facilities continues to grow.