Commercial property funds: why it’s not 2008 all over again

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Commercial property funds are once again in the spotlight - for all the wrong reasons - following a slew of funds moving to prevent investors from cashing in their chips. More than half of the £25 billion invested in the sector is now 'gated'.

Funds have also moved to mark down the value of the business they own, by 10 per cent or more.

So should investors who cannot sell units of a suspended commercial property fund be alarmed?

The consensus view, from a range of market commentators, including financial advisers and wealth managers, is that the current situation is not a repeat of 2008 - the last time commercial property funds en masse moved to suspend trading.

Silver linings to the Brexit cloud and how to profit

LOWER LEVERAGING LEVELS

During the 2008 crisis there was a sharp drop in the value of the buildings and offices commercial property funds invest in, which resulted in steep capital losses for investors. 

But this time around, although there is economic uncertainty over whether the property market will cool following last month's Brexit vote, there one big difference - leverage levels are much lower. Therefore in the event of a sustained downturn there won't be massive bank loans to repay.

Charu Lahiri, investment manager at Heartwood Investment Management, cites an example. She says: 'London-based developer Land Securities' loan-to-value ratio (a measurement of leverage versus portfolio value) was around 60 per cent in 2007, but is now down at 19 per cent.

'UK banks are also better capitalised, which will reduce fears of contagion into the broader market.'

Philip Gadsden, manager of the St James's Place Property fund, concurs: 'A key difference is that back in 2009 the global financial crisis was caused by debt, but at present there is not an over-leveraging position in the British property market.

'If we look at listed UK property companies, the amount of on-balance sheet debt that they have is at a very comfortable level, and they can withstand very significant shocks to their businesses and not have a debt issue.'

RENTAL INCOME WON'T BE AFFECTED

But, on the whole, while last month's Brexit vote may have a negative impact on both commercial and residential property prices, particularly in London, commentators do not expect reductions in rental income, because there is not a supply overhang.

Rowan Dartington's Guy Stephens explains: 'The level of pricing adjustment that we are seeing, of around 20 per cent, implies a reduction in rental income and a significant increase in voids through recession.

'The most pessimistic forecast of the economic hit to the UK has been the possibility of a shallow technical recession of two negative quarters from Mark Carney. Does this really translate into businesses shutting up shop and vacating premises en masse as we navigate Brexit trade deals?'

Another point, made by Money Observer's associate editor Andrew Pitts, is that it is important to remember that while many property funds are closed for business, they will continue to pay investors the income they receive from their tenants.

'In this respect you should probably only sell (assuming you can) if you've reached the point when you need the money, rather than taking a capital loss and forgoing the income that your investment generates.'

It is also worth pointing out that the buildings owned by the commercial property funds, particularly the bigger players with £1 billion or more in assets, tend to have well-known tenants, such as supermarket stores including Tesco and Waitrose. So even if the value of the buildings declines, the rent should keep on being paid. 

ENCOURAGING MOVES

Last week Legal & General moderated the markdown of its commercial property fund from -15 per cent to -10 per cent.

Aberdeen has also moved to increase the value of its property fund. Two weeks ago it reduced the value of its Aberdeen UK Property Feeder fund by 17 per cent - a process known as a 'dilution adjustment'. But the dilution adjustment has now been reduced to between 6 per cent and 7 per cent.

Martin Gilbert, chief executive of Aberdeen Asset Management, comments: 'This should allow us, in time, to remove the dilution adjustment altogether.

'The post-referendum environment now seems to be settling down with thoughts of reducing property holdings being balanced by the fundamental long-term attractions of the asset class.'

The moves by Legal & General and Aberdeen are encouraging, but these are early days.


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