I have had an offer to invest in a new property fund and wondered if you had any views on the commercial property market as a whole.
In order to make a decision on whether or not to invest in anything we should always consider the basic principles of investment – risk and reward. Always ask what the potential is with the investment you are considering over and above a guaranteed investment such as cash. Following that, consider what the potential risk is. Most of the sales literature you see will focus on the former, not the latter, which is normally held under a stone.
In mathematical terms it is called Sharpe ratio – the potential for return over a risk free asset. We make the same decision on a Friday night. There is a beer in the fridge and something average on the television and you receive a call asking you to go out. All the questions you have will centre around the potential you have for a return over the risk free option – but you will still go out anyway!
Why do people not approach their investments this way?
Consider that property is one of many different assets. Like gold, equities or fixed interests, they are cyclical assets which perform well at different times in markets.
Property and commercial property are having a good run now, but the last year has seen returns on income diminish to below cash levels, which for most will make it an uninteresting option in today’s terms. There is a reason why it is believed that performance is not a guide to the future and right now is an example of that.
The capital returns have also been very attractive but can they go any further?
Many of the major property funds are currently invested heavy in cash elements in them. Why would they do that? For the most part it is because commercial property is considered to be expensive and there is a lack of appropriately priced property – i.e. they believe it may fall.
A lack of decent property and a big demand during a booming economy leads to higher rents and capital values, but a faltering economy with falling corporate profitability leads to companies dropping costs or even going bankrupt. Properties can then remain empty for some time which has a negative impact on house prices.
For the salesman telling you that property is classed as low risk, take it from me it isn’t. Property has a low deviation normally because there is little trading. Even when the market falls people hold onto the assets, which once again eases volatility.
Consider that most property funds have a block on you selling the asset for up to six months. If the market is falling and there is a move for an exodus out of commercial property the manager can stop you selling your asset.
Meanwhile you may have to wait and watch the price fall and fall. The key reason for this is liquidity. Unlike other forms of investment, property is highly illiquid and if you need to access the capital quickly, you may find you are disappointed.
This may also be the reason why commercial property funds are holding excessive cash amounts. If they are being forced to sell off in difficult markets they will be spared the embarrassment, as they will hold enough cash and be able to pay investors back with that. I can see no other reason for them holding the excessive cash amounts now other than the belief there will be a fall.
To that end there lies a further risk with new funds so I would generally stay clear of them. With a new fund I am unable to assess how well it has performed in difficult markets especially coming off a boom in the asset class. It is possible they will be ill equipped to deal with it.
For advice on property investment or if you have a financial query, call 0800 0112825 or e-mail info@wwfp.net
The value of shares and investments can go down as well as up
Follow us on Twitter
Become a fan on Facebook
Subscribe to the RSS Feed