Property funds: sell London, buy Germany

The real-estate sector in the UK had a fabulous 2006, ending the year 46% higher than it started it. But as far as fans of commercial property funds are concerned, the fun has only just begun: the long-awaited launch of real estate investment trusts (Reits) on the London market is expected by a great many analysts to kick-start further rises.

We're not convinced. Reits have their attractions: ten of Britain's largest listed property firms have already converted to Reit status and as a result will now be exempt from capital gains and corporation tax, as long as they pay out 90% of their income to shareholders. But that doesn't mean now is the time to buy them.

Why we don't recommend UK property funds

Property firms have traditionally traded at discounts to the net value of their assets, and for good reason property is illiquid and investing in it therefore carries a certain amount of risk. However, today the sector trades on an average premium to net asset value of around 9%, something that seems hard to justify, given that yields on London office accommodation are officially only 4.7% (and anecdotally a great deal lower). You can, as the bears constantly and quite rightly point out, get a better return on a Halifax savings account, and without the risk. Note that the last time the yield on commercial property stocks was below the cost of capital was during the dotcom bubble of the late 1990s. None of this looks like it's bothering the bulls: analysts are expecting to see a "wall of money" enter the sector this year, both from retail investors and pension funds. Odds are they'll be disappointed with their returns, says Justin Modray of Bestinvest. There is a real need for investors to "realign their expectations".

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

German property funds are more attractive

Those who are keen to gain exposure to commercial property might be better advised to look at Germany. The volume of German commercial property transactions doubled last year, but from a very low level, and prices have barely budged for a decade. Indeed, many think a combination of economic growth, the low supply of office space and the expected introduction of Reits to the market this year should mean that ,even as prices in London start to stagnate, in Germany they begin to soar. MoneyWeek Roundtable member Jim Mellon thinks that we are entering a "ten-year bull market on German property" and Mick Gilligan of Killik tips two offshore funds, Invista European Real Estate Trust and Develica Deutshland, as a good way to get into the market.