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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
20 September 2016

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 (see explanation below). 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

The office sector has been the best performing sub-sector over the past 3 and 5 years; however, it has lagged the industrial sector slightly over the past year. The London market has driven the sector’s strong performance but was hardest hit by Brexit with rental growth expectations falling sharply following the vote.

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 1, 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. Big city rents are high, but 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 remained relatively robust. Supply of leasable space is more or less unchanged in the office and retail sectors, 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.

Performance of the IA Property sector vs. IPD UK All Property Monthly Index over fifteen years

Source: Lipper IM to 01/09/2016. Past performance is not a guide to future returns.

Annual percentage growth
Sept 11 -
Sept 12
Sept 12 -
Sept 13
Sept 13 -
Sept 14
Sept 14 -
Sept 15
Sept 15 -
Sept 16
IA Property Chain-Linked Index 4.55% 5.94% 10.49% 5.55% 9.08%
IPD UK All Property Monthly 3.82% 5.59% 19.19% 15.82% 4.22%

Most property funds underperform the IPD UK All Property Monthly Index. This is in part due to the relatively high levels of cash they are forced to hold in order to meet any redemptions. With interest rates low, cash currently earns very little so this acts as a drag on performance.

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.

Five year performance

  • IA Property sector

    +40.89%

Data correct as at 01/09/16. Please remember past performance is not a guide to future returns.

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 June 2016. 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

Henderson has lifted the suspension on its UK Property Trust to allow clients to trade with effect from 12 noon on 14th October 2016.

Trading in the fund was suspended on 5 July 2016 as the managers received a large number of requests from investors to sell their investment. Property funds hold a cash buffer to satisfy sales, which is usually sufficient to ensure the managers are not forced to sell properties. However, the increase in requests after the EU referendum was such that the cash buffer was reduced to a level the managers were not happy with.

Henderson therefore temporarily stopped investors selling (or buying) units in the fund to afford the managers time to find suitable buyers for some of their properties. If forced to sell quickly they could be required to accept less than fair value to the detriment of remaining investors.

Since July, the managers have completed, exchanged or agreed to sell 23 properties. Cash is now at a level the managers feel is sufficient to meet normal redemption requests and they will aim to keep it at around 20% of the fund for the foreseeable future. While the managers hope to keep the fund open, any significant increase in requests from investors to sell their holding could cause the fund to re-close.

Please note, a fair value adjustments has been made to the value of the fund, which investors should consider before making a decision to buy or sell units. The fair value adjustment was applied as the managers were concerned property valuations did not accurately reflect the impact Brexit would have on property prices. It currently has the effect of reducing the value of the fund’s properties by 1.96% (down from 5% in the weeks following the Brexit vote).

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.

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.

They have taken this decision to afford the managers time to find suitable buyers. If forced to sell properties more quickly, there is a risk they would be required to accept less than fair value, negatively impacting remaining investors in the fund. From an existing investors’ perspective, we view this action to be correct for the circumstances. The managers are not currently able to confirm when the fund will reopen. However, they will review the situation regularly and we will keep investors up to date.

The fund invests in UK commercial property with the majority of properties located in the South.

Threadneedle has lifted the suspension on its UK Property Fund to allow clients to trade with effect from 12 noon on 14 October 2016.

Trading in the fund was suspended on 6 July 2016 as the managers received a large number of requests from investors to sell their investment. Property funds hold a cash buffer to satisfy sales, which is usually sufficient to ensure the managers are not forced to sell properties. However, the increase in requests after the EU referendum was such that the cash buffer was reduced to a level the managers were not happy with.

Threadneedle therefore temporarily stopped investors selling (or buying) units in the fund to afford the managers time to find suitable buyers for some of their properties. If forced to sell quickly they could be required to accept less than fair value to the detriment of remaining investors. Since July, the managers have completed, exchanged or agreed to sell 25 properties totalling £167m. Cash is now at a level the managers feel is sufficient to meet normal redemption requests. While the managers hope to keep the fund open, any significant increase in requests from investors to sell their holding could cause the fund to re-close.

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 predominately invested in the UK (around 80%) with the remainder invested across Europe, mainly the Germany, France and Sweden.

The fund fell sharply as a result of the UK’s decision to leave the EU and underperformed the average property fund; however, it fell to a lesser extent than the fund’s FTSE 350 Real Estate benchmark. The fund’s performance has generally been in line with the benchmark over the past five years.

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

The manager favours properties located outside of London as she feels demand has pushed prices to unjustifiably high levels. She expects greater rental growth from the ‘Big 6’ cities; Bristol, Birmingham, Manchester, Leeds, Glasgow and Edinburgh, where demand is strong and supply is weak.

Retail properties account for more than 38% of the fund and 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.

Over recent months, the manager has experienced a large number of requests to sell units in the fund. These requests increased further in the wake of the UK’s decision to leave the EU, as investors became concerned over the prospects for the UK property market. This caused the cash level within the fund to fall to a level the managers were unhappy with, which led M&G to halt trading in the fund on 5th July 2016. They have taken this decision to afford the manager time to find suitable buyers. If forced to sell properties more quickly, there is a risk she would be required to accept less than fair value, negatively impacting remaining investors in the fund. From an existing investors’ perspective, we view this action to be correct for the circumstances. M&G is not currently able to confirm when the funds will reopen. However, they will review the situation regularly and we will keep investors up to date.

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

Outside of the three main sectors (industrial, retail and offices) the fund also has exposure to nursing homes/hospitals, student accommodation and hotels. Outside of physical property, the fund can hold a blend of cash, property derivatives, bonds, and real estate investment trusts (REITs). This currently accounts for around 22% of the portfolio and the manager prefers this to simply holding cash as it is still correlated to the property market.

Over recent months, the manager has experienced a large number of requests to sell units in the fund. These requests increased further in the wake of the UK’s decision to leave the EU, as investors became concerned over the prospects for the UK property market. This caused the cash level within the fund to fall to a level the manager was unhappy with, which led Aberdeen to halt trading in the fund between 6th July 2016 and 13th July 2016.