One would hope that having to formulate constantly updated views on 11 core asset classes and very many sub-investments would allow justification for a blind spot. In reality, we have learnt that property is an emotive subject and it is deemed imperative to have an opinion. Therefore, to reduce the claims of idleness we have updated our view to 'negative'.
My strong view is…
I have no strong bias on UK commercial property. Well that's not totally true – I am vehemently against the illiquidity of bricks and mortar funds and their swingeing fees. Memories of 2007 and the gated funds loom large in my memory and I have seen little to suggest that the inherently illiquid nature of UK property funds have ameliorated.
On the fees front, I think it is insane that investors should be forced to shell out for AMCs, ongoing charges, transaction fees and taxes for the privilege of accessing the asset class. 2%+ TER? You are having an expensive laugh. These factors can only be justified if there is a genuinely attractive opportunity in real estate.
In terms of the current fundamentals it is nearly impossible to justify from an income perspective. While a UK commercial property fund's property assets might yield around 6%, you need to adjust the yield for the cash weighting (typically 20%) and taxes, meaning that the yield you get in your pocket is close to 4%. This is better than govvies, but far less attractive than many other asset classes, particularly when adjusted for the illiquidity factor.
Genuine recovery out there
However, sometimes it is sensible to accept moderate liquidity risk, higher charges and an uninspiring yield if there is an obvious recovery potential in capital values.
Here there is more cause for debate, in my unlearned opinion. In some sectors, in some parts of the UK, there is tangible evidence of the spare capacity being used and genuine signs of a recovery in prices. Southeast retail would be an obvious current example. However, our research suggests that UK commercial property funds are an inefficient method of exploiting the opportunities on offer, due to their diverse nature.
So what are the alternative routes to a selective UK commercial property recovery? Reits are one such avenue, but the specialist companies are mostly over-valued and have been a primary beneficiary of the 'close your eyes and hope for the best' desperation for yield investment policy employed by many global investors. This is not a UK phenomenon, but rather a global epidemic, obliterating (for the most part) any blatant value in listed real estate markets. Finally, any investment in Reits should be considered part of your equity allocation, as we have found out in the past six years.
Strong conviction
Maybe I do have a strong view then. However, as I have previously mentioned, there is a time and place for everything and we benefited from holding UK commercial property between the early days of our firm in 2003 and when we became nervous over illiquidity and valuation in early 2007. Then, in mid-2009, encouraged by contacts in the inter-dealer property markets (who told us that German insurance companies and Australian pension funds were clamouring to get their hands on UK prime real estate) we exploited a distressed opportunity.
This value had unwound within 18 months and we sold in the early months of 2011. Since then most UK commercial property assets have gone the way of the UK economy – listless and lumbering – before staging an unconvincing recent recovery. There is a fair chance that this recovery will continue, as long as our forecast of the UK’s re-emergence from stagnation is correct.
However, with plenty of slack remaining in the economy, no obvious medium-term inflation pressures, better yield opportunities elsewhere, no evidence of a wide supply/demand imbalance and structural concerns over fees and liquidity, it is unlikely we will change our view in the immediate future.
