Commercial Property Update - December 2007


There has been much media speculation over the UK Commercial Property sector over the last few weeks and, in light of this, we wanted to provide you with our view and recommended way forward.

Long term investors in UK Commercial Property funds have seen lucrative returns – average annual returns have been well in to double digits over the last five years – with the added benefit that these funds have little correlation to UK and global equities.

Indeed, at the beginning of this year, the average return for this sector was 20.5% * (for the twelve months period to 1 January 2007). This ongoing growth stimulated massive inflows of cash into UK Commercial Property funds through the first four months of 2007, largely from private investors chasing unsustainable levels of returns. From April 2007, these returns started to reduce against a backcloth of rising UK interest rates, fears of problems in the sub-prime mortgage markets in the US spreading globally and concerns about the slow down of the growth of the UK and global economies. Consequently, cash inflows into the funds started to reduce and, soon after, as investment markets became more volatile, outflows began to increase.

All of this has resulted in a situation where media speculation and changing investor sentiment is driving the UK Commercial Property market in an irrational way. That said, there are some real issues arising and some potential risks as we move forward.

For example, the average return for this sector has fallen dramatically to -5.8%* for the twelve months period to 1 November 2007. Falls in fund values have been compounded by the managers having to re-assess current property values and, in many cases, down-grading them by circa 2% to 5% month on month over the last few months. Steps have also been taken to protect existing investors by introducing dual pricing. There has been much media speculation about this but, in simple terms, it means investors withdrawing from the fund will pay a penalty to do so (for most funds this is between 4% and 6%).

Ongoing liquidity is an important consideration, particularly during this period when the funds are experiencing net outflows of money. Having discussed matters with both the New Star and Norwich property teams, we have been reassured that this is still manageable but we intend to watch developments closely and will be maintaining our dialogue with them. On the performance outlook, while they feel volatility will continue to be the major feature of this market over the short term, they expect the funds to recover to produce more realistic levels of returns from mid 2008 at around 6% - 7% per annum.

Regarding global property, returns from this sector have been similarly affected by the ongoing US sub-prime credit crisis and continued negative investor sentiment. However, we believe that the rapid economic growth and pace of demographic change within the Eurozone, coupled with continued large scale inner city development throughout the emerging markets will provide significant investment opportunities for these funds moving forward.

In summary, we remain satisfied that the UK Commercial and Global property sectors will continue to provide valuable diversification opportunities over the medium to longer term. Returns are likely to reflect long-run historic trends with property delivering overall returns between equities and bonds (6% - 8% per annum).

On this basis, we do not recommend any changes to your existing asset allocation or fund selection strategies. However, if your personal situation has changed or you have concerns about Commercial Property, or any other aspect of your financial planning, that you wish to discuss in more detail, please do not hesitate to contact us.

We will issue further updates on Commercial Property and investment markets generally when appropriate.   

* Source: Money Management Magazine dated February 2007 and December 2007.

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