High-rise funds climb nearer to their peak

Jenne Mannion wonders if new investors have left it too late to join the UK office party

ou might spend long hours in the office, but would you consider investing in it?

ou might spend long hours in the office, but would you consider investing in it?

Many ordinary savers who answered "yes" to that question have done rather well out of their decision. Funds investing in commercial property have turned in stellar performances over the past decade, beating shares and bonds hands down. Not surprisingly, they've now become a popular choice among investors.

The funds usually hold a portfolio of commercial property nationwide, ranging from the City of London to regional offices, retail buildings and industrial warehouses - as well as cash and shares in property companies such as Land Securities. They aim for profits from both rental income and capital growth - and since they avoid residential property, they are not at the mercy of fluctuations in the housing market.

Buoyant rental returns of around 7 per cent, rising property prices and a strong economy that has fuelled demand for office space have all helped increase the "yield" of commercial property funds.

A glance at the IPD UK All Property index, which measures returns from the sector, reveals robust growth. In the 10 years to 30 March this year, the average annual return has been 11.3 per cent. Compare this with 8.1 per cent for the FTSE All Share index and 8.54 per cent for government-backed bonds (gilts).

Over the past three years, commercial property has put shares and gilts in an even deeper shade: the index's average annual return has been 13.7 per cent, compared with 2 per cent for the All Share and 6.3 per cent for gilts.

Such is the popularity of these funds that three new ones - from Britannic Asset Management, Scottish Widows and F&C - have been launched in the past 12 months alone.

But a growing number of independent financial advisers (IFAs) believe the asset class is now overvalued and that new investors could be in danger of buying at the top of the market.

"Commercial property used to be seen as the investment cure for all ills - particularly during the bear market in equities four years ago," says Ben Yearsley of IFA Hargreaves Lansdown.

"A lot of people have piled in as a result, but the best returns are likely to be behind us."

Stuart Cowe, property research manager at the fund manager Scottish Widows Investment Partnership, predicts rental yields will hit a 15-year low this year. Nevertheless, he says commercial property will offer an average annual return of 10.5 per cent - "with much of the upside coming from capital growth due to the weight of money chasing property".

New Star's commercial property fund was the manager's top-seller last year. Its marketing director, Rob Page, doesn't believe that any overvaluation of commercial property today would lead to a huge fall in returns. "Previous property crashes were characterised by a huge oversupply of new development," he says. "This is not the case now."

While not everyone is so bullish about commercial property, a stake in such a fund should at least offer investors a degree of stability.

"You'll not see the same big daily movements in property as you would in equities, where the stock market can move up and down quite sharply," explains Mr Yearsley. "Steady returns mean commercial property can provide a good anchor to a diversified portfolio."

That anchor should be a small one, however - no more than 10 per cent of your portfolio, says Mr Yearsley. This figure is still too high for some. For example, Adrian Shandley of IFA Premier Wealth Management recommends 5 per cent.