Commercial property: on shaky foundations

Commercial property prices across the sector are a third lower than their mid-2007 highs. Now there are some signs of a recovery. But should investors pile in? Some already are. Data from the Association of Investment Companies (AIC) shows that recent buying means discounts to net asset values in the UK investment-trust property sector narrowed from 32% at the end of September 2008 to 6.5% at the end of September 2011.

One of the sector's "strong pulls" is income, says Nia Williams in Mortgage Introducer, "with yields currently averaging 6.3%". Improving returns are also a factor. They're up "23% over the last three years to the end of September 2011 compared to the average investment company increase of 18%". Richard Kirby, manager of the F&C Commercial Property Trust, agrees: "the initial sharp bounce-back has been replaced by a year when performance has been largely driven by income.

In September 2011, the annual total return was 8.7%, of which 6.9% was attributable to income, according to the Investment Property Databank (IPD) Monthly Index." Even retail property, exposed to the embattled consumer, has performed well. Recent figures from the IPD show that, during the last year, landlords have received 2% more income from their retail properties.

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So why are we nervous? For starters, it looks like the recovery is losing steam. The last quarter saw the smallest climb in overall values since the recovery began. Over the last year, capital growth has slowed to just 1.7%. A recent report from the Royal Institution of Chartered Surveyors (RICS) showed falling demand for office, industrial and retail space for the first time this year. There was also a widespread increase in spare space. Even central London saw falling occupier demand and rental expectations.

That's bad news for investors in real-estate investment trusts (Reits). Kelvin Davidson at Capital Economics forecasts that "office rents in the capital will start to fall again in 2013. If anything, the latest RICS data suggest this downturn may come through a little sooner". Even some big property fund managers are cautious. Jason Baggaley, manager of the Standard Life Investments Property Income Trust, told Fundweb that "some weakness in pricing is anticipated over the next few months as more stock is brought to market".

So if it is income you're after, go for solid defensive equities. Many offer yields that can match those offered by a still shaky commercial property sector.