Should you rush into Aim’s property boom?

When it comes to the impact of rising interest rates, much of the focus has been on residential property. A headline in The Independent this week talked of mortgage meltdown', while the price of shares in housebuilder Bovis dived after the group warned of a "recent slowdown" in sales as rate hikes began to take effect.

However, the commercial property market is, if anything, in a worse state, with yields comparing unfavourably to investing in risk-free government bonds. Last week, one of the UK's largest property fund managers, Standard Life, warned that investors would see the value of their investments cut by 6.7% if they tried to withdraw money from its commercial property funds. The move came "in response to a net outflow situation", a spokesman told Reuters, saying that the group needed to cut payouts to cover the cost of selling properties.

The move bodes ill for the entire sector. As Mark Dampier of Hargreaves Lansdowne told The Times, "it's not that the property market's going to crash tomorrow, but if you say that a trust might be revalued, it's a self-fulfilling prophecy because people start pulling out of the sector". Indeed, consultancy Capital Economics reckons that commercial property prices are likely to fall by 18% in real terms over the three years from 2008 to 2010.

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So it's no surprise investors are looking for the exit. But where are they going? Look no further than the Alternative Investment Market (Aim), where several recent listings by foreign property funds have been warmly received. Fundraisings by China Central Properties (CCPL) and Dev Property Development (DPD), which invests in Indian real estate, have been among the largest on the market this year, raising £144m and £138m respectively. They are just the most recent of around 50 foreign property funds to have listed in London in the past two years, raising £7bn of equity, according to analysts Oriel Securities. The best performers in the sector last year, by share price, include Orchid Develop­ments (OCH), which invests in Bulgaria, Vinaland (VNL), a Vietnamese property fund, and Dolphin Capital Investors (DCI), which invests in Croatia, says Sharlene Goff in the FT. The latter is up 86% in the past year alone but that doesn't mean you can just stick a pin in the map and dive in. As Goff points out, "overseas funds are not a guaranteed success. Some offer yields little better than the UK, they can be fairly illiquid, and they have the added risk of currency fluctuations."

And even if you like the look of a market, some funds are better than others. Take German property, a favourite of MoneyWeek's for some time now. It's still relatively cheap, and a resurgent economy is already putting upward pressure on rents. However, some sections of the country's commercial property market aren't faring so well, especially since speculative foreign investors started piling in back in 2005, says Tom Stevenson in The Daily Telegraph. Of last year's purchases, 80% came from overseas investors. "Unsurprisingly, retail warehouses, which yielded 7.5% in 2004, now offer about 5.5%. Shopping centres have moved from a 6.5% yield in 2003 to about 5% now."

Germany is still a great investment story its economic prospects look far healthier than the UK's but we'd recommend buying into an established property fund, rather than one that is only now going into the market. One we like is Summit Germany (SGL), which came onto Aim last year. It now holds over e750m in commercial real-estate assets, and looks cheap on a p/e of six.

But there's another, more serious risk for investors to be aware of, says Algy Hall in Investors Chronicle. Aim-listed property funds can take more risks, because "Aim doesn't place the same limits on debt levels that the main market does". Summit Germany says it will target a loan-to-value ratio (LTV) of 80% equivalent to a 400% gearing level. This gives it the potential to make larger gains than if it was merely relying on equity. But if things don't go to plan and property prices fall, the fund could be left with no equity and some very large debts. And Summit is by no means the most highly-geared fund. Indian investment group Trinity Capital (TRC) has no restrictions on gearing and Raven Russia (RUS) can employ a 95% LTV. That's the same as gearing to a massive 1,900%.

But as long as you understand the higher risks involved in investing in these funds, there are some tempting options out there. Take Macao. The former Portuguese enclave is the only place in China where gambling is legal and last year took in more money than Las Vegas, replacing it as the global gaming capital. It's targeting a record 25 million visitors in 2007, up from 22 million last year. A second border gate with mainland China and a new ferry terminal are opening this year, and its international airport continues to expand. Wages are rising at about 20% a year, while the population is expanding rapidly. Residential property prices have doubled in the past few years, and many believe they will do so again. Investors Chronicle likes the look of Macao Property Opportunities (MPO). At 60%, the fund's LTV is relatively low, equivalent to about 150% gearing. But a better bet might be the Speymill Macao Property (MCAU) fund, tipped by our own Merryn Somerset Webb in The Sunday Times, which is likely to have fully invested its funds sooner.