Interactive Investor

Property funds offer post-Brexit opportunity

21st July 2016 14:34

Phil Cook from ii contributor

There has been a good deal of debate around the issues affecting UK open-ended property funds following the referendum vote to leave the European Union.

Much of the debate looks at the problems that the rush for the door has caused - the illiquid nature of the underlying asset, the suspension of trading, prospect of falling prices and others - and so, as with any discussion, it is worth looking at the opposite view before taking action.

So rather than selling, why might investors wish to retain their holdings or even increase them?

Markets aside, commercial property as an asset class has attractive characteristics for long-term investors who see beyond its illiquid nature.

Rental yield cushions falls

Traditionally, values have kept up with inflation and owners benefit from a steady income stream which, with interest rates at 0.5%, is hard to achieve elsewhere at this time.

Values will fluctuate with the economy, availability of financing and longer-term trends such as foreign investment, but that is true for the prospects of other investments as well.

The yield generated by rental income often provides a large part of the overall return. This enhances the return when prices rise and cushions any falls.

Funds with reasonable yields of 4% can experience falls in capital values at a similar level and effectively see little overall change in their price.

This protects existing investors from dips in the value of the asset class, albeit not the significant drops experienced in the secondary and tertiary sectors during the financial crisis of 2008.

For new investors, any fall in capital values makes the yield increase and will be seen as a positive that should in time support the market. If the UK sees interest rate cuts in the future, this is likely to enhance the attractiveness of the yield from commercial properties.

Sterling boon

Investors also need to consider whether the significant drop in the price of sterling since the referendum will prove a boon to the commercial property sector. For foreign investors, a 10% fall in the value of sterling provides an attractive entry point into the asset class.

For existing investors there is the cost of exit. The mechanism of the bid/offer spread is designed to adapt to varying cash flows, with the bid price usually floating 5.5% below the offer price.

When a fund experiences a net inflow the offer price is used and with net outflows the bid price is used.

This ensures existing investors are protected from additional costs when new properties are acquired from inflows and also when properties are sold to produce cash for those selling.

Most funds moved to a bid price earlier in the year and so investors have already seen a 5.5% drop in the value of their holding. There are likely to be further exit costs: for instance Aberdeen recently introduced an effective 15.5% dilution levy on redemptions.

Investors need to consider whether any anticipated falls in the commercial property market will be greater than the cost of selling.

The additional costs borne by those leaving the fund offers brave investors an opportunity. The lower price applies to investors who wish to buy into the fund, offering a significant discount to obtain exposure to the asset class.

For those who believe the predicted fall in commercial property will be short term or limited in nature, it offers an interesting opportunity to enter at a very attractive price.

Phil Cook is a private client partner at Thomas Miller Investment.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.