Property investors feel the chill
By Chris Gilchrist    28th November 2007

Over the five years to Spring 2007, investors in UK property funds roughly doubled their money. Since then it’s been a downhill ride and managers are gloomy about the outlook.

Between May and November, one of the funds selected by our sister site – Everyinvestor – as one of its best buys in the sector, New Star Property, is down 30% and other funds in the sector have done even worse.

But bigger investors in funds open only to pension funds have suffered even more - both M&G and Norwich Union have slashed the prices of these funds and forced investors to wait if they want to get their money out.

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Our funds are not so shoddily run as pension funds
Delays are most unlikely to happen with Everyinvestor’s selected funds. Two of them, New Star and SLI, hold securities as well as physical property so they can easily raise cash to pay out investors who want to sell. M&G’s parent, the Prudential, would not want to see M&G’s reputation tarnished by forcing delays on investors.

But there’s no doubt the property sector is now in retreat. Few analysts expect any improvement until well into next year.

How our selected Property funds have performed
		Investment return* over
Fund	Income yield	6 months	1 year	3 years	5 years
M&G Property	2.6%	-9.8%	-5.5%	NA	NA
New Star UK Property	3.8%	-11.0%	-9.1%	+20.0%	+50.6%
SLI Select Property	3.4%	-15.4%	-4.5%	NA	NA
Sector average	1.8%	-10.4%	-6.1%	+31.6%	+28.5%
* Including reinvested net income. Data to 27/11/2007. Source: Financial Express

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Double whammy for property values
The two main factors behind the slump in UK commercial property are supply and interest rates. Between 2000 and 2006, demand for property ran well ahead of supply and rents rose steadily, especially in the office market in the South-East.

But thanks to low interest rates and rising markets, it was easy for developers to finance new developments, so the cranes started to rise everywhere, but especially in London. A surplus of new City office space is now forecast for 2008-09.

Rising interest rates were already beginning to affect developers before the sub-prime credit crunch, but the effect of this was to make banks warier about offering finance and determined to be rewarded for the risk involved.

So development finance has got more costly. But higher interest rates also mean that the future value of a stream of rental income- the discounted cash flow - is lower in today’s money. That has forced valuers to reduce the valuations of many properties.

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More pain to come now the ‘prime premium’ is back
How much more property values will fall is uncertain. Valuers already report a widening gap between ‘prime’ and secondary property. ‘Prime’ - the top-quality High Street shop, the best shopping mall, the best offices- usually commands a premium over the rest, but by early this year the premium had almost vanished as people scrambled to buy anything they could get their hands on.

Now the ‘prime’ premium is back. This should be good news for investors in M&G Property, because M&G has always been a cautious investor in this sector. If, as expected, the Bank of England cuts interest rates soon, this will also help to restore confidence to the sector.

SLI has only about 12% of its money in the UK, with as much as 20% in Japan and 10% in Hong Kong. Its recent poor returns are due to a worldwide slump in the prices of REITs, the listed companies that own property portfolios, following a boom up until the end of 2006. The slump now shows signs of coming to an end, so this fund is likely to be the first of our trio to recover and by next Spring could be showing positive returns again.

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New Star management shot themselves (and us) in the foot
I am somewhat annoyed about New Star. Its UK Property fund has a good manager and a sensible strategy, but the opportunistic and frankly greedy management at New Star chose to launch an International Property fund over the summer and pitched it so successfully that many financial advisers recommended that investors switch out of the UK fund.

The result was big withdrawals from the UK Property fund, and this has undoubtedly hurt its recent performance.

I wouldn’t recommend either M&G or New Star funds as an investment now, but SLI Select Property remains a good ‘alternative’ investment to balance investments in shares.

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risk warning - please read
The value of your investment and the income from it can go down as well as up and you may not get back a significant proportion of your investment. Past performance is not an indication of future performance. If you are in any doubt as to the suitability of an investment, you should seek independent financial advice.

Article produced by EveryInvestor.co.uk