Using foresight in commercial property investment
Managing Director, Worldwide Financial Planning, Writes:
I had a number of emails and calls regarding a column I wrote about hindsight and foresight - particularly in light of the ongoing commercial property fiasco.
Most of the readers of this column over the last ten years may have noticed how we walk when others are running, and the calamity that is the overselling of commercial property funds and REITS (real estate investment trusts) is another classic example.
For the last eighteen months I have noticed countless advisers telling customers to move from with profits to property funds. My response to the reader, who has written in, is to mention frying pans and fires and I have warned of the impending plummet on five occasions over the same period.
It is generally believed that most use hindsight to invest rather than foresight. I believe all that matters, is where you are going not where you are coming from, and for eighteen months have been advising readers to be cautious about commercial property. Those of you who took that guidance may have missed the sharp re-rating of commercial property over the last month, and those who invested may wish to consider the remainder of this column.
There has been a sharp sell-off of commercial property and fund managers have taken the opportunity to curb this by effectively re-pricing their investments funds to a bid price (more eloquently put as a very stiff penalty of near 5%).
It was most surprising to see the response in many of the trade advice press where advisers were asking for greater clarity on how these funds work in terms of their ability to do this. (So what you are really saying is that you didn’t know what you sold your client into).
So why have many missed it? The signals were there for ages: The yield (income) from commercial property is less than cash, so why would you take the risk going forward? The current yield for property is also around 4.7% compared to short term borrowing rates of near 6%. (1) Why on earth is that a bargain for an investor? Sure, I hear the wannabe adviser saying that commercial property might have a low yield but there is also the chance of the property price increasing! What? If that happened the yield will drop further – so that doesn’t make sense.
I advised that when the yield dropped below 6% that the investor should have sold. Instead I have watched advert after advert extolling the virtues of this asset class as part of a portfolio of investment funds.
It has taken some time for the penny to drop with the market, that the monetary policy committee’s stance (assault) on interest rates and the residential property owner is cause for concern. This has made its way through to a near 20% drop in the price of major UK property equities and REITS (another potential fiasco I advised against) (2).
The equity market is now pricing in expectations of higher interest rates, and large property shares are now trading at a discount to their net asset value of 20% indicating once again that they believe property capital values will come under pressure.(3)
The general consensus on interest rates is that we will see a top rate of 6.25% - 6.5% (3),
although I hope that the rises have their impact on the economy before the next monetary policy committee meeting.
So what are the options for you if you have a commercial property fund? Consider reducing your exposure, but be careful of any tax consequences. If you are invested via a pension there will be no tax disadvantage. If you are invested via a collective such as a unit trust or Oeic consider that any gain should be less than your capital gains allowance and seek the advice of a chartered accountant if it is. If it is inside a bond the issues are considerable and seek advice from an IFA.
(1) Morley fund managers
(2) Williams de Broe
(3) Jupiter fund group
For advice on any commercial property fund call email or if you have a financial query, call and speak to one of our Independent Financial Advisers on 0845 230 9876 or e-mail info@wwfp.net
Worldwide Financial Planning Ltd are authorised and regulated by the Financial Services Authority. 'The FSA does not regulate Credit Cards, Will Writing and some forms of mortgage and Inheritance Tax Planning.'
Information given is for general guidance only, and specific advice should be taken before acting on any suggestions made.
The above represents the personal opinions of Peter McGahan.
All information is based on our understanding of current tax practices, which are subject to change.
The value of shares and investments can go down as well as up.
Commercial property investment - the risks and rewards
26 June 2007
Reader Writes:
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 0845 230 9876 or e-mail info@wwfp.net
Worldwide Financial Planning Ltd are authorised and regulated by the Financial Services Authority. 'The FSA does not regulate Credit Cards, Will Writing and some forms of mortgage and Inheritance Tax Planning.'
Information given is for general guidance only, and specific advice should be taken before acting on any suggestions made.
All information is based on our understanding of current tax practices, which are subject to change.
The value of shares and investments can go down as well as up.
'Worldwide Financial Planning Ltd are authorised and regulated by the Financial Services Authority. Worldwide is entered on the FSA register www.fsa.gov.uk/register/ under reference 440668
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