Is commercial property about to have a new lease of life?

By July 23, 2021Investments
High rise commercial properties

It has been a difficult period for commercial property funds. According to data company Morningstar, the value of the property funds sector has almost halved in value since 2019. The troubles for the sector began immediately after the Brexit vote in 2016, when most property funds suspended dealing due to sustained withdrawal requests in the wake of the decision to leave the EU, and difficulties in accurately valuing property portfolios at the time. This suspension was relatively short lived, and most funds had reopened by the end of 2016.

Fast forward to December 2019, when a small number of funds again suspended trading just a few days before the last General Election. For example, M&G suspended its’ Property Portfolio – which invested in commercial retail parks and offices across the UK – after blaming “unusually high and sustained outflows” caused by Brexit uncertainty and the struggles of the beleaguered UK retail sector.

Next up came COVID of course, with the uncertainty created by the pandemic leading to a suspension of all property funds, as material uncertainty over the accuracy of the value of property portfolios, and lack of liquidity in some funds, forced a longer suspension. Whilst the largest players in the sector resumed dealing again in October 2020, several funds, including funds from AEGON and Aviva, have announced that they will be wound down and will return money to investors, although investors may have to wait more than a year to get their money back. So, what has caused so much damage to commercial property funds? The answer is in the fact that property behaves differently to other types of investment asset.


The reasons why commercial property funds are different

First, portfolios of ‘bricks and mortar’ properties are far less ‘liquid’ than other investments. If you own a large portion of a commercial property fund and you want to sell your investment, It is likely that the fund manager will have to sell some buildings to have enough money to pay back your investment. In periods of market volatility, this can cause huge problems. This is why a handful of commercial property fund managers were so quick to ‘shutter’ their funds back in December 2019, because they feared the sudden rush of investors looking for their money back would make them forced sellers of their best assets.

Another important reason behind the closure of several commercial property funds is that the assets held within them are valued significantly lower than they were before the pandemic. You don’t have to be an investment genius to work out that changes to the way people live and work – especially with more flexible options for people who can work from home – mean that demand for office buildings could be considerably lower in future.

Whether you are talking about offices, warehouses, shops or industrial locations, the value of the underlying assets (the buildings) is dependent on the demand for that type of property. This is determined by economic growth and the economic viability of the businesses who might want to use those buildings. Other factors, such as the quality and location of the building, also help to determine the yield (rental value) that the building can achieve.

At the same time, commercial property is a broad and varied sector. While shops and traditional office buildings were hit hardest by the lockdown restrictions, there was vastly increased demand for industrial buildings and warehouses linked to e-commerce and distribution. It is therefore highly likely that those remaining open-ended funds will gradually adapt to the new normal and take advantage of the different types of properties that are increasingly in demand.


Is the worst over for UK property?

Just because some commercial property funds have closed, it doesn’t mean that the sector itself is about to collapse. In fact, most funds in the sector are in positive territory for the year so far, and the current economic conditions could leave them well-positioned to benefit from the theme of inflation that is dominating investor sentiment. Real estate in all its forms tends to do well during periods of inflation. This is because as the economy expands and the demand for goods and services increases, rents tend to grow. In addition, many leases on commercial property are linked to inflation, which ensures the owners of the buildings receive a higher income should the cost of living rise.


Regulation, Regulation, Regulation

The suspensions within the property sector caught the attention of the regulator, the Financial Conduct Authority (FCA), who launched a consultation in August 2020 to consider proposals to try and avoid a repeat of the suspensions that were seen in the property sector after the start of the pandemic. The FCA have proposed that investors would need to give notice of withdrawal from funds – of between 90 and 180 days – so that property fund managers are aware of withdrawal requests and could manage their property portfolio more effectively, to ensure liquidity is sufficiently available to meet the expected withdrawal demands.

The consultation period has now ended, and an announcement is due later in the year. Amongst the current issues that need to be resolved include the ability to continue to hold property funds in an ISA (as the withdrawal notice would be incompatible with existing ISA rules) and the difficulties platforms and providers would have in managing withdrawal requests.

We await the outcome of the consultation to see the impact of any new rules introduced. Nevertheless, we feel it is clear that commercial property remains a varied and diverse asset class, that could benefit from the prevailing economic conditions and opportunities the new way of working could present.


If you are interested in discussing your investments with one of our experienced financial planners at FAS, please get in touch here.


This content is for information purposes only. It does not constitute investment advice or financial advice.