Constructing a shares ISA? Try bricks and mortar

Commercial property might not be your first port of call when looking to invest, but some insiders suggest the sector is set to see a turnaround that may mean double-digit returns.

Although last year wasn't exactly stellar for commercial property, with the market as a whole down around 3 per cent, a slight improvement in the global economy this year will put the UK property market back on an uphill track.

Claire Higgins at BNP Paribas expects commercial property returns to come in as high as 8 per cent annually over the next five years. "As the underlying economy and accompanying sentiment improves, so will returns," says Ms Higgins. "By 2015, when the economy reaches above trend growth, commercial property total returns will rise to above 10 per cent."

With the deadline for individual savings accounts (ISAs) fast approaching on 5 April, you might be keen to allocate a portion of your £11,280 stocks and shares allowance to a commercial property fund. Not only can these funds potentially deliver attractive returns, but they can help diversify your investments, so all your eggs aren't in one basket.

"Relative to cash and bonds, the income from property funds looks quite attractive," says Martin Bamford of Informed Choice, the independent financial adviser. "You can get 4-4.5 per cent without aking undue levels of risk – certainly less risk than many equity funds."

There are two main types of fund that give you access to commercial property, such as offices, shops, factories and warehouses. Dubbed "bricks and mortar" funds, these invest most of your money in property, keeping a small amount in cash as a buffer should things take a turn for the worse. The other type is called a property securities fund, and invests in companies involved with property, such as Land Securities.

"The property sector continues to include a lot of different funds, ranging from conventional UK bricks and mortar to exotic overseas property securities," says Mr Bamford. "Property is a fairly catch-all term which can include everything from the reasonably low-risk to the very risky. We consider 'property' to be real property rather than shares in a property or land company."

It is also worth bearing in mind that buying a bricks and mortar fund means you are spreading your investment by owning a different type of asset, whereas the other style of fund means you're building up the amount you have in shares.

"If you build a portfolio, you want investments that do different things," says Tim Cockerill at stockbroker Rowan Dartington. "Bricks and mortar funds tend to do something different to the equity markets."

But even if the outlook for commercial property seems rosy, dark memories from the not-too-distant past still haunt investors, who bought these types of funds and found themselves locked in.

"During the crisis, the bricks and mortar funds closed down to people wanting to cash in – people couldn't take their money out, because if these funds were 90 to 95 per cent invested in buildings, they couldn't sell them to raise cash in order to repay investors," says Mr Cockerill. "Now these funds invest nearer to 80–85 per cent in property and the rest is in cash and short-term debt, in case lots of people want to sell out."

It might be comforting that property funds hold a certain amount in cash, but there's also a fine balance to be struck. "The problem is you have attractive income from property, but holding a large amount in cash dilutes the return," says Henry Lancaster, an investment analyst at Coutts. Although these funds are designed for investors to easily get in and out, he says property is still, fundamentally, tough and expensive to buy and sell.

Even if it's now easier for investors to sell a fund, there are still other issues to face. "If interest rates and inflation go up, people with mortgages could struggle with payments," says Petronella West at Investment Quorum. "Property prices would fall significantly if borrowers get squeezed, as a result of interest rates rising."

There are also property "zombies" on the loose – those property companies that have been left highly indebted following the crash in 2008, which wiped out their capital. Although these companies are seen as riskier than quality prime property, Mr Lancaster argues some could offer opportunities over the long-term, especially as the UK economy improves.

"Investors can afford to wait patiently for capital growth opportunities, as they are being well remunerated with a high income yield, especially relative to traditional sources of income such as cash and bonds," he adds.

However, any further relapse in the UK economy's growth could really hit commercial property. "Funds which hold a high proportion of retail premises could struggle, with several high-profile failures on the high street already this year," says Mr Bamford. "A property fund is only really as strong as the financial strength of its tenants, regardless of the quality of the tenancy agreements and upwards-only rent reviews."

Still, even if economic growth remains sluggish this year, experts believe there are enough factors in place for property returns to improve. "There are early signs the UK will achieve 1 per cent growth this year – but that's enough to make property returns look attractive," says Mr Lancaster.

When deciding how much of your ISA you should have in property funds, Mr Bamford says up to 10 per cent is suitable. "Our preferred property fund is currently Ignis UK Property, managed by George Shaw."

The Ignis fund has returned 12.55 per cent over three years and has had an income of 3.2 per cent, says Mr Bamford. "It has good geographical diversification, with holdings in London, Glasgow and Sevenoaks within the top 10 holdings," he adds. "It offers potential for total returns, mainly driven by income, and low correlation with other mainstream asset classes."

Patrick Connolly, left, at AWD Chase de Vere recommends the M&G Property Portfolio, which is managed by an established team with a long-term, consistent track record. Mr Connolly also likes how the fund invests in quality properties across London and the South-east. "The main focus is capital preservation and any growth from rental income," he adds.

Although these funds are not without their risks, having a small allocation to a commercial property fund, and more specifically, a bricks and mortar one, can diversify your investments and potentially offer growing returns in the coming years.