Investors pour money into property funds – but will there be 19pc returns again this year? (2024)

Investment returns from commercial property have soared in the past two years. But are the investors who are now pouring cash into the sector coming to the party too late?

Over the past 12 months almost £4bn has flowed into funds that invest in commercial property. This amount exceeds the previous peak set in 2006, at the height of the property bubble.

And in 2014 commercial property made gains of 19pc, the highest annual return since 1988, according to the Investment Property Databank (IPD).

Will the next 12 months also produce big returns? Many experts are optimistic, with some tipping total returns of 10pc or more, although they don’t expect a repeat of last year’s stellarperformance.

Here we explain why commercial property could continue to shine, while weighing up the arguments against putting too much of your Isa into property funds.

Why are experts predicting double-digit returns again this year?

One of the main reasons for the boom in commercial property over the past couple of years is that Britain’s economy has been growing.

When the economy is doing well, there are more tenants seeking space for their shops, office and warehouses, so property owners feel more comfortable about charging them more rent. This then boosts capital values.

Mike Deverell of Equilibrium, the wealth manager, said: “There is historically a strong correlation between economic growth and commercial property values. When the economy is in recession prices tend to fall, but when it is growing prices tend to rise.”

One reason for analysts’ confidence that commercial property will continue to perform well this year is that, for the past four quarters, growth in commercial property values has outstripped growth in rental incomes.

This has not happened since March 2007. The financial crisis significantly reduced the value of buildings, and these capital values have only now started to recover.

Aviva, the insurance giant that pours billions of pounds of its customers’ money into commercial property, expects this trend to continue in 2015. The company has predicted total returns – rental income plus capital growth – of 18pc.

Richard Levis, a commercial property analyst at Aviva, said the fact that a rise in interest rates looks at least a year away should boost capital values further.

“Record low interest rates provide further support to the relative pricing of real estate and will aid the recovery in property markets,” he said.

Duncan Owen, head of real estate at Schroders, the fund manager, agreed. He also predicted that 2015 would be another year of double-digit returns. “The recovery in the economy, combined with low levels of development, means that the balance between demand and supply is now swinging in favour of landlords and we anticipate that rental growth will accelerate,” Mr Owen said.

Reasons to be cautious

But one of Britain’s most experienced commercial property fund managers has cautioned that investors should not get ahead ofthemselves.

Gerry Ferguson, who runs the Aberdeen Property Trust, which manages £3.4bn of savers’ money, said investors should expect to pocket anything between 8pc and 15pc this year, but warned that from next year rental income would once again be the main source of returns.

“London, in particular, is starting to look expensive and some of the yields on offices are the lowest I have seen in a long time, which is why I have been looking increasingly outside the capital,” Mr Ferguson said.

“I am now taking risk off the table and buying properties that have sustainable income because capital growth will slow down in the next year or two.”

Others are also more cautious in the longer term, particularly as an interest rate rise will surely be on the cards at some stage. Aviva, for instance, predicted that total returns would average 9pc from 2016 to 2019.

The funds the experts rate

Popular funds that own “physical” property such as offices, student accommodation and hotels, as opposed to shares in property companies, include the Aberdeen Property Trust. It is one of the biggest and oldest portfolios and has returned 27pc over the past three years, while the average fund has returned 23pc.

Other funds that are regularly tipped include the Henderson UK property fund, also up by 27pc since 2012.

Another popular choice is the Legal & General UK Property fund. Over five years this is one of the best performers, returning 46pc against an average of 33pc.

There are also commercial property investment trusts, but most are trading on a premium – the difference between a fund’s market value and the value of its assets – of 10pc or more, which makes these funds less appealing.

On average, funds will not beat the returns on the market as a whole, because ofthe fees they charge.

Over the past year a typicalproperty fund has gained 12pc.

How five of the biggest bricks and mortar funds have performed

^{Source: FE Trustnet}

Don’t invest too much

Experts recommend that only a small part of your portfolio, perhaps up to 10pc, should be held in property funds.

Their caution comes after savers struggled to withdraw money from some of these funds during the financial crisis. When funds own property directly they find it hard to raise money quickly to pay investors back.

Most portfolios now include buffers of cash to meet withdrawals, but some advisers are still worried.

Andrew Merricks of Skerritt Consultants said: “I am not prepared to put money into a fund that could lock the door and keep hold of my investors’ cash. The sector has previous form and history could repeat itself during the next downturn.”

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