Are property funds and REITS an accident waiting to happen?

By Ian Fraser

The Estate Agency Times

February 12th, 2007

UK real estate funds likely to severely harm your your wealth; image courtesy of The Economist

REMEMBER technology funds? Seduced by the prospect of annual returns of 30 per cent to 40 per cent, British investors piled into this investment sector during 1998 and 1999. For many, it seemed like a passport to instant wealth and UK fund management groups cashed in on their naivete with the launch of specialist funds just as the market peaked. And, of course, latecomers to the sector ended up losing their shirts once the dotcom bubble burst.

Six years on, something similar is going on in property funds.

Hardly a week goes by at the moment without a fund management group launching a new property fund, many of which are focused on investing in UK commercial property. Since the turn of the year alone, new funds have been announced or launched by Standard Life, Threadneedle, Norwich Union and New Star.

It’s easy enough to understand why. There’s a veritable buying frenzy among retail investors and the fund managers want a slice of the action.

Latest figures from the Investment Management Association show that retail investors pumped a record £3.6 billion into open-ended property funds during 2006. This represents one-quarter of the total amount of new money invested in UK mutual funds, and the same as was invested fixed-interest funds. And more than a third of the money going into new issues is going into property funds.

However people putting their savings into such funds may be in for a rather nasty surprise.

Commercial property is one of the most cyclical of sectors. Rising interest rates invariably put valuations under pressure. There are already signs that we have reached this point in the market cycle, according to data from Lambert Smith Hampton. The property agency recently revealed that UK transactional yields rose from 4.89% at the end of September to 5% by the end of December.

The Financial Services Authority is seriously concerned and in early February warned retail investors that over-exposure to the sector could seriously damage their wealth. In its 2007 Financial Risk Outlook, the FSA said: “There is some concern that, if there was a significant correction in the property market, retail investors could be adversely affected both by a drop in the value of their residential property and through any exposure to commercial property sector through their fund portfolio.” It would be a sort of double whammy.

Alarm bells are ringing in other quarters too. The OECD last year estimated that British property is among the most over-valued in the developed world. However this has not dissuaded many of the fund management groups from continuing to seek to persuade investors to part with their cash.

It is therefore refreshing to see that at least two fund groups seem alert to the risks. Richard Kirby, manager of the F&C Commercial Property Trust recently said: “The market could see some correction, especially for secondary stock as the market adjusts to a new environment where income returns and rental prospects assume a greater importance in driving total returns.”

Commenting on high street retail properties, Standard Life Investments’ head of property Alec Watt, recently said: “Against a backdrop of moderate consumer spending and a degree of overcapacity, we expect landlords will achieve rental growth below inflation over the next few years. After discounting for depreciation and liquidity, the net return to investors suggests some overpricing in current yields.”

I know its muted, but at least F&C and SLI are acknowledging there could be trouble in store.

Retail investing was ever thus. It typically takes individual investors (and their independent financial advisers) a while to spot a performance bandwagon. But by the time they have jumped aboard, it’s often already beginning to lose momentum – or even about to crash.

  • This article was followed by predictions from the IMF in March 2007 that the UK’s housing market bubble was ripe for bursting. See Property could slump, warns IMF

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2 Comments for “Are property funds and REITS an accident waiting to happen?”

  1. […] was already on the wall for UK commercial property funds as early as February 2007, when I wrote this article in one of the […]

  2. […] out £715m for the housebuilder Crest Nicholson at the  peak of the property cycle. It was already widely known in commercial property circles that a crash was imminent. The bank’s corporate arm finally […]

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