Commercial property: investors rush for the exit

We've been warning readers to avoid UK commercial property for some time and now it seems we are being proved right. In the past month, managers of several property funds, including New Star and Standard Life, have cut prices by up to 6.7% because more investors sold out of the funds than bought into them.

More and more analysts believe the market has peaked, with rising interest rates making rental yields look unattractive. As think tank Capital Economics notes, the yield on commercial property in May this year was actually below that paid on ten-year Government bonds. As gilts are risk-free, you would normally expect a larger return for taking the risk of investing in commercial property. Rising rates have pushed up the cost of buying property too. As the FT's Jim Pickard says, it's "nearly impossible for highly leveraged buyers to justify paying" current prices.

It's no surprise that prices have been pushed so high. Money has flooded into the sector in recent years New Star's £2.2bn UK Property Fund was the most popular fund during last year's Isa season. In fact, Martin Allen of Morgan Stanley says that inflows into property funds have hit the peak rate of inflows in the tech sector seven years ago and we all know what happened then. Property fund managers have tried to downplay the cuts. New Star's Rob Page tells The Daily Telegraph that the flood of panic-selling' stories "makes my blood boil". But as Justin Modray of Bestinvest told The Independent, "if outflows are really as small as they're saying, and they don't expect them to continue, then why change the pricing"?

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

For now, funds are selling property shares to pay for withdrawals. But if they end up having to sell physical assets, it would worsen any downturn, says Allen. He also notes that the property market "rarely, if ever, stops at fair value, either on the way up or on the way down". Capital Economics already expects an 18% (real-terms) fall in commercial property prices between 2008 and 2010; investors in these funds could have a lot more to lose.