A less nerve-wracking route into commercial property

As the UK moves ever closer to triggering the beginning of negotiations over its withdrawal from the European Union, now might not seem like the most obvious moment to be thinking about an investment in UK commercial property. The asset class was hit hard in the immediate aftermath of the UK’s vote to leave in last year’s referendum and Brexit continues to pose some worrying questions: if you believe, as most economists still do, that the UK economy will slow as the UK departs the EU, demand for commercial property is likely to suffer; also, the UK’s financial services industry, seen as at risk from a tough negotiating process, is a major driver of the London real estate market.

The counter argument is that real estate valuations recovered last year once the shock of the referendum result dissipated. Moreover, property remains attractive to investors in a climate where income-producing assets that also generate long-term capital growth are in short supply – and likely to remain so with interest rates now expected to remain lower for longer.

In which case, where can retail investors and their advisers get exposure to real estate while managing the very real risk of further volatility as the UK’s negotiations with the EU ebb and flow over the next two years?

Part of the answer to that question is that closed-ended funds represent a less nerve-wracking route into commercial property. In an open-ended fund, the fact that the manager must cope with inflows and outflows of investors’ money can cause serious problems in extreme circumstances, particularly when the fund is invested in illiquid assets such as property. We saw this following the referendum when several open-ended funds felt compelled to put penal charges on withdrawals or to close altogether for a period, rather than be forced into unwanted asset sales in order to pay investors.

By contrast, investment companies, with a fixed chunk of share capital in place, do not suffer from this difficulty – a collapse in investor confidence may result in shares in the fund trading at a much wider discount to the value of the underlying assets, but the manager has no need to make portfolio changes.

This is not to suggest that commercial property investment companies are somehow immune from setbacks and volatility in the underlying asset class. The value of their portfolios will rise or fall accordingly, and the share price may reflect that disproportionately, according to investor sentiment.

Nevertheless, investment companies provide a more stable route into commercial property. And, as Mick Gilligan, head of fund research at the wealth management firm Killik & Co, points out in an article for Citywire this week, the diversity of the commercial property fund sector means there are interesting funds to consider even if you buy the bearish case on real estate and Brexit.

Gilligan points to specialist investment companies whose assets may prove resilient in the context of Brexit. They include Tritax Big Box, which invests in large logistics facilities, Ground Rents Income, which has long-term holdings in index-linked assets, GCP Student Living, which specialises in student accommodation, LondonMetric, which has holdings in out-of-town retail sites and warehouses, and Civitas Social Housing, which has contracts with housing associations and local authorities.

Every investor’s circumstances vary and it may be that none of these funds are appropriate for a particular individual’s objectives or attitude to risk. Nevertheless, Gilligan’s suggestions are a reminder that, with a fund structure well-suited to the asset class and with fund selections chosen for the prevailing climate, the investment company sector provides a route into commercial property even at what might seem a worrying time.