Property is making its mark as an attractive asset class this year, with some experts expecting that trend to continue. Laura Miller looks at where the opportunities - and risks - lay.
People in financial services are talking about UK property. One real estate fund manager from a European investment house has been in the UK twice already this year to see prospects, according to those in the know.
Wealth managers and advisers have also started to look again at real estate investment trusts (REITs) and their attitude to property as an asset class has changed a lot of late.
Thesis Asset Management director Giles Marriage said his firm has recently increased its allocation to commercial property funds. This ranges from 3.5% in a 'growth' portfolio to 10% in a 'high income' mandate.
"We have done this in preference to fixed interest investments, for its solid income yield and potential for some capital growth," Marriage said.
Oaktree Wealth Management chief investment officer Ian Brady said this year he has upped his clients' exposure to non-central London commercial property from nothing to 5%.
Talk of the town
What has sparked this recent buzz for buildings? According to Brewin Dolphin head of portfolio strategy Guy Foster: "The UK economy is proceeding apace and the commercial property market is one of the best mechanisms for accessing that market.
"Furthermore, tight credit conditions curtailed the supply, giving landlords enhanced pricing power."
Legal & General Investment Management multi-asset fund manager Justin Onuekwusi elaborates: "The debt buyers haven't really been in the market since 2007-08, but they're returning now and giving a boost to demand.
"Secondly, rental income started to increase in prime real estate throughout 2013 and there are signs of life in the secondary market also. Thirdly, we are seeing a pick-up in capital values outside of London, particularly in areas where you can still make purchases at healthy yields."
The figures are certainly interesting. The FTSE EPRA/NAREIT Developed index, which tracks REITs, is up about 22% over three years. And while it had a bit of a bumpy ride last year, it still ended 2013 up 2.45%.
The IPD UK All Property Monthly Property Index, which measures ungeared total returns to directly held standing property investments, is up about 21% over three years, and did particularly well last year, ending 2013 up 10.9%.
According to Aviva Investors, this strong performance is set to continue. The investment house is predicting double-digit UK property performance for 2014-15, with returns moderating thereafter, and believes UK real estate has the potential to return 6.5% a year over the next five years.
Aviva Investors global research manager for real estate Chris Urwin said: "We have upgraded our near-term forecasts as a consequence of stronger-than-expected market momentum, and in expectation of further improvements in the economic environment, investor confidence and lending conditions.
"We now expect the IPD UK All Property Index to deliver double-digit returns this year and next."
So, which areas of the property market look most attractive right now? According to Foster, the improving environment is gradually filtering from the South East out through the country.
"The Midlands and the South West are performing well, while more northern areas remain tepid," he said, adding that office units are still most sought after.
Urwin believes that the majority of UK real estate sectors remain attractively priced relative to other income-producing asset classes, though he added the recent increase in government bond yields poses a risk to the relative attractiveness of central London markets, parts of which recently saw yields fall to record lows.
By contrast, Urwin predicts higher-yielding sectors could outperform over the next five years, and he recommends that investors get involved in the market quickly while opportunities remain.
"While secondary assets and regional offices have most appeal, market sentiment and pricing is moving quickly, so we believe acting rapidly is important," he said.
Amid all these positive noises, however, risks remain, and while they may not outweigh the advantages, clients will need to be made aware of the downsides.
Firstly there are structural risks with the avenues into property investment, as Foster points out: "REITs are potentially prone to equity market volatility, they can have gearing, and could be subject to secondary market illiquidity."
Direct property funds, he added, can see their standard liquidity terms withdrawn in extreme market conditions.
However, for Onuekwusi of much greater importance is fund selection and picking a good active manager.
"A skilful property fund manager will not be invested heavily in the most illiquid parts of the market at times of stress," he said. "They will also have the scale to get access to deals that smaller fund managers may not have visibility of.
"Not picking the right manager is always a risk when you go down the actively managed route. Given its added liquidity risk, this is particularly the case within property."
Exposure to property is likely to be relatively small in most balanced portfolios. But with improved economic and market conditions, commercial property across the UK – and not just in central London – is looking like a strong diversifier with the potential to produce good returns in the near future.
Property fund picks
Brewin Dolphin head of portfolio strategy Guy Foster likes the SWIP Property fund and the TR Property Investment Trust.
At Thesis, Giles Marriage likes the L&G UK Property fund for its prime office and London focus, and the SWIP Property Trust because it is a larger more diverse fund, with a slightly enhanced yield.
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Rathbone Unit Trust Management head of multi-asset investments David Coombs believes the easy money has already been made in the UK commercial property market, but is still relatively positive there are opportunities out there. He prefers REITs, but bemoans the lack of bottom-up vehicles that target niche areas.
"As fund-buyers, it is frustrating, and the product market needs to play catch-up with its US counterpart, where targeted vehicles are readily available," he said.
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