Commercial property punts

Whenever I am in a social setting and I tell people that I am an investment adviser, the next question is almost always, inevitably, "So where would you invest right now?"

It's always a frustrating question as there is rarely a simple answer or a stand out area. We believe in diversification and the importance of asset allocation, and of course it is impossible to accurately predict the future.

However, right now whenever I'm asked that question, I am able to give the simple answer people want to hear. That answer, right now, is commercial property.

I last wrote about property in my February blog where I highlighted that not a single forecaster was publishing their predicted returns for property. By contrast, every major bank and fund management group likes to give an equity forecast and the average prediction for the FTSE 100 was 7,560; this was expected to be reached by this coming December.

With just four months to go, I would be amazed if we got anywhere near 7,560.

In my previous blog I concentrated on property and predicted that the Investment Property Databank (IPD) would return over 12% for the year, and circa 10% for the funds that we have invested in. Unfortunately, for true bricks and mortar funds that actually have to buy and maintain buildings, as well as maintain a cash buffer, this means funds rarely get close to the 'theoretical' and cost-free IPD.

We're now three quarters of the way through the year, and it seems like a good time to assess how my prediction looking.

The IPD has returned 10.85% to the end of July, which annualises at over 18%. Our Equilibrium portfolio has returned 7.27% to the end of August, which annualises at around 11%. Over 12 months, the return from the IPD has been 17.4% and our funds 12.3%. So at present, it looks like my forecast will be a little too cautious.

In February I suggested that commercial property was a good option for surplus cash and I think it still is. The party is far from over and I would predict almost exactly the same returns over the next 12 months. My reasons for being so cheerful are:

1) Rental yields are still strong with the average IPD yield at 5.8%.

2) The Royal Institute of Chartered Surveyors (RICS) are predicting rents to start increasing again, something we haven't seen for a while.

3) The number of empty properties remains high, but rising demand should see this fall, consequently boosting rent.

4) The lack of new buildings over the last few years may result in demand outstripping supply.

When you combine all that, the outlook is certainly rosy. Property returns are also highly correlated to economic growth and with more good figures published last week, this only adds to my positive outlook.

But…. please, please be careful. Not all property funds are the same. I would avoid those with a large weighting to property shares which don't diversify your portfolio. Property shares act just like any other equity.

I would also avoid any fund that has borrowings within it. Borrowing or gearing can produce fantastic returns but it can also cause disastrous losses (see our recent blog on the collapse of the Invesco fund.

If you take a sensible and simple approach to property investment, then you can achieve some great returns at the moment, but with the added benefit of low correlation to the other asset classes.

Try to be too clever by chasing higher returns and you won't get the diversification you want, and could end up losing the whole lot.

Colin Lawson is founder and managing partner of Equilibrium Asset Management

He writes a regular blog about wealth management for Private Client Adviser