By ROBERT HARLEY 13/07/2007
This has been a roller coaster week for many UK commercial property funds. While the prices of the underlying properties are still standing firm, the selling prices for some bricks & mortar property funds have fallen by as much as 5%.
| "However, there is no cause for panic." |
However, there is no cause for panic. These price movements only affect investors wishing to sell; the underlying fund values are largely unchanged. Provided you are investing in commercial property for the longer term, these movements are mostly irrelevant.
Why have the selling prices changed?
Unlike stock market funds, property funds have rather hefty expenses when they purchase the underlying assets (properties), usually in the region of 5.25% (4% stamp duty plus agent’s commission and legal expenses). This is usually reflected by the price at which investors buy units, so even if you buy the fund with little or no initial charge (as is the case through Bestinvest) they’ll still be paying around 5.25% more than the actual value of the underlying properties (known as the creation price). When there are more buyers than sellers the fund manager usually buys back the units from sellers at the creation price so that they can be passed directly onto buyers, this means sellers benefit from recouping the c5.25% costs of buying property. However, when there are more sellers than buyers the manager might only buy back the units at the value of the underlying properties or, worse still, after factoring in the costs of selling properties (typically 1.25%) to pay for the redemptions. The latter is known as the cancellation price and could be around 6.5% below the creation price.
What has happened this week is that some fund groups have been experiencing net redemptions, prompting them to move the selling price from creation towards the cancellation price. Whether they have been over zealous is a debateable issue. It is highly unlikely that funds which have over a quarter of their assets in cash and property shares, such as New Star Property, will ever have to sell physical properties to fund redemptions, so moving to cancellation pricing so quickly appears harsh. On the flip-side, fund groups do not directly profit from this, it instead protects remaining investors in the fund as it avoids any risk of them potentially subsidising those selling out. If the manager believes that net outflows will continue then moving towards the cancellation price is a sensible manoeuvre, but those groups that have done so this week after just one or two days of outflows are arguably being rash and may be doing so to discourage outflows from the funds, hence protecting their revenue.
In any case, we think there is a clear need for greater transparency so that property fund investors know exactly where they stand. We would like to see fund groups display the creation price and value of underlying assets alongside the buying and selling prices on their websites, as this will help investors determine whether they’re selling at a disadvantageous time.
| "While commercial property prices have held firm this year, the share prices of UK property companies have fared less well..." |
While commercial property prices have held firm this year, the share prices of UK property companies (and REITs) have fared less well with many falling by around 15-25%. As well as hurting property funds that primarily invest in these companies (e.g. Aberdeen Property Share), bricks & mortar funds that partially invest in these shares for liquidity (e.g. Norwich Property & New Star Property) have also suffered. This is why some bricks & mortar funds have actually posted small losses over the year to date, even before the recent moves towards cancellation pricing. However, falling share prices do mean that some property investment companies now arguably look good value, as they’re trading at around 15-20% below the net asset value of their property portfolios.
We believe that commercial property remains a worthwhile asset that investors should continue to hold in their portfolios. It has been widely accepted for some time now that the UK market is slowing, with annual returns likely to fall into high single digit, but a crash is very unlikely. The rising availability of overseas property funds is also welcome, as it provides investors with an opportunity to widen their property exposure, given prospects and returns tend to be very localised in nature.