The best home for property assets?

David Prosser looks at why investment companies offer a superior structure to open-ended property funds for investors looking to invest in property.

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David Prosser looks at why investment companies offer a superior structure to open-ended property funds for investors looking to invest in property. 

property

Is it time for financial advisers and their clients to take a fresh look at the UK commercial property sector? With some notable exceptions – logistics assets and areas such as data centres – the past couple of years have not been kind to commercial property. The pandemic hit demand for office space, as more people worked at home, and accelerated the trend away from the high street, hitting retail property. Industrial space also suffered.

Now, however, much of the commercial property sector appears to be firmly in recovery mode. Data from Capital Economics suggests that total returns, including both rents and capital appreciation, across the sector as whole hit 24% over the year to the end of March. That’s one of the best periods on record.

The bounce back has been strongest in the industrial property market, where the demand for warehousing space has boomed amid the supply chain disruption of recent months. The ongoing shift to e-commerce, which requires logistics capacity, has also provided a boost.

In the retail sector, meanwhile, there is growing evidence of green shoots after what has been a torrid time. Rents in the sector were falling even before the Covid-19 crisis, but started moving higher over the first quarter of the year. Office rents have also begun to increase once again, with people returning to the workplace slowly but surely following the pandemic.

There are plenty of reasons to be cautious. For example, it is not yet clear how far the return to work will continue; if the way we work has changed forever, the UK may simply have too much office accommodation. Equally, in the retail sector, a cost-of-living crisis and the increasing likelihood of a recession hardly augurs well for demand for space. Those problems may even begin to hit e-commerce.

Nevertheless, for investors with the expertise to make smart decisions in commercial property, the outlook now feels more encouraging. And many financial advisers will be more conscious than ever of the need to look beyond stock markets in the current environment. Increased volatility and recessionary expectations underline the importance of diversification.

In which case, real estate investment trusts (REITs) may catch the eye. In fact, many of the property development REITs listed on the UK stock market have bounced higher in recent months and are currently attracting buy ratings from sector analysts.

The alternative is an investment company REIT. Like property developers, these companies benefit from the tax advantages of REIT status, including exemption from corporation tax and the ability to pay distributions that are taxed as income rather than dividends, but they’re run as investment funds, rather than real estate businesses.

The AIC’s UK Commercial Property sector is the place to look for these funds, with around 15 to choose from. In many cases, shares in these funds currently trade at a chunky discount to the value of the underlying assets, which might be of interest to bargain seekers.

Such discounts are, of course, a function of the closed-ended structure of investment companies; with a fixed number of shares in issue, the price of the fund is determined by demand and supply for those shares, and may, at times, move out of sync with the value of the portfolio. Still, while financial advisers are sometimes put off investment companies because of this nuance, in the case of illiquid assets such as property, it is a real virtue.

The alternative is an open-ended fund, but these have repeatedly run into trouble during difficult times, with managers forced into fire sales of property to pay investors looking to get out – or even to close the funds to withdrawals. The recent decision of one large open-ended property fund, Janus Henderson UK Property, to wind itself up underlines the trend away from this sort of structure for property exposure.

Investment companies simply offer a superior structure for those looking to invest in property assets.