Follow the funds out of commercial property

Fund managers in the commercial property sector are beginning to get the jitters, and investors should take note. Managers at F&C’s Commercial Property Trust (FCPT) have forecast an end to the rocketing capital appreciation that has pushed up returns in this once unloved asset class, while the Westbury Property Fund has said that it will begin investing in companies backed by a property asset – principally ports – rather than investing directly in commercial property. What’s more, property tycoons Vincent and Robert Tchenguiz, reputedly worth more than £500m, are ridding themselves of their property empire.

Encouraged by past performance, investors’ money has continued to flood into the sector. But although that’s helped to push up commercial property prices, it’s also pushed down yields, as rents have failed to rise in line with prices. As Jonathan Russell says in The Observer: “What landlords are receiving in rent may not cover the interest payments on the capital used to buy the buildings.”

Other signs are rife: to end-June this year, the yield from F&C’s Commercial Property Trust had dropped from 6.47% to 5.63%. The Bank of England’s latest Financial Stability review points out that the 15% rise in commercial property prices to end-May was higher than current rents and interest rates could justify. But “although the unsustainability of current returns is widely recognised, the impact and severity of the slowdown could still take some investors by surprise”, Alex Watt, managing director of property investments at Standard Life Investment, told The Scotsman.

That’s because, with yields falling, they are depending on capital appreciation to deliver the returns. However, the gap between high capital values and rents is enough to scare the daylights out of the brothers Tchenguiz, so expect others to follow their lead. As Iain Keys, director of real estate at fund manager London & Capital tells The Daily Telegraph. “The UK market is seen as quite hot” and, as price rises slow, “money piling into the UK” will go elsewhere.

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