ETFs are ideal for commercial property plays

ONE of the biggest casualties of the financial crisis was the commercial property sector – capital values slumped 45 per cent in the UK, according to the Investment Property Databank (IPD). The recession also saw occupier demand contract, which drove up vacancy rates and forced down rents.

But since the summer, we have seen an astonishing recovery in UK (and global) commercial property returns. Real estate broker CB Richard Ellis reported that turnover in the EMEA investment market rose 40 per cent in 2009’s third quarter, with the UK experiencing 50 per cent growth. The IPD estimates that UK commercial property values have risen by 5.4 per cent since August 2009.

Commercial property returns have fallen but they remain significantly above cash or bond yields, leading some market observers to speculate that a bubble is forming in the sector.

So given all these worries surrounding the sector, should investors be considering jumping into commercial real estate positions at the moment? Well, while there are concerns in some quarters about a bubble, Howard Richards, head of investment at property consultant Drivers Jonas, says that the rapid rise in values is simply a reaction to how low the market fell. “The weight of money suggests to us that the market is sustainable and pricing will hold up for this year unless something bad happens to the economy. In London, there is a feeling that rents have hit the floor and investors like that sort of stability.” Furthermore, commercial property, in the UK at least, is still lagging the recovery in equities and corporate bonds. This would indicate that the market has some way left to go before it becomes overvalued. Ernst & Young’s recent ITEM Club report on commercial property said that prices will fall.

Whatever your view on the commercial property sector, the easiest way to take a punt is through property exchange-traded funds (ETFs). Since they invest in companies and real estate investment trusts, they can be liquidated more easily than a fund that buys up physical property. Therefore you can nimbly exit positions should the market turn against you. However, you are left exposed to the fortunes of the company and its management, which may dilute performance relative to values.

Even if you are using ETFs, it is worth researching the individual underlying components of the fund – for example, British Land and Segro alone make up 36 per cent of the iShares UK property fund – and what those firms invest in. That is, if you are hoping to take a punt on City values remaining supported from a lack of developments coming on stream in 2011 and 2012, then there is little use having exposure to companies invested in retail space outside London.

Investors feeling a little braver might consider commercial property outside the UK – Blackrock offers ETFs on the US, European, developed world and Asian property markets. Societe Generale strategists prefer Asian real estate companies for their high growth-low yield story while Europe and the US offer investors high yields.