Mark Dampier: Commercial property comes good

Back in March, I mentioned that I was starting to detect signs of optimism amongst commercial property fund managers after a torrid couple of years. Directors Don Jordison and Chris Morrogh at Threadneedle had done better than most during the downturn because they had kept a lot of the fund in cash.

Since then they have been gradually investing more in the market as opportunities have arisen. The fund size now stands at £52m and, by mid- October, they expect the cash levels to be down around £10m (unless they get a flood of new investors in the next few weeks).

At Hargreaves Lansdown, we have had a negative view on property for many years (in fact, in hindsight, such a bearish stance started a couple of years too early). However, I have now moved to a more positive stance and believe it is time for investors to reappraise the sector.

Having said that, I do not expect the UK economy to shine over the next 12 months – far from it. I believe we are living in a phoney war at present with none of the politicians willing to tell us the truth. This is because the truth is almost too painful to consider; our economy is in dire straits. However, for that reason, I expect interest rates to stay extremely low for the foreseeable future and this is good news for commercial property.

One of the consequences of the crash in the commercial property market is that yields have now risen to 8 per cent, around double the yield available on government gilts. Only a few years ago it was actually below the gilt yield so that is a rapid change and suggests commercial property could be the cheapest it has been since the 1990s.

Income is the prime reason to buy commercial property. It accounted for 77 per cent of total returns between 1993 and 2003, and an overwhelming 94 per cent between 1993 and 2009. The overall yield on the Threadneedle UK Property Trust should be about 8 per cent once it is fully invested.

It is fair to say that most of the sellers have now gone from commercial property and liquidity has improved. In fact, there might be too much liquidity in property funds, meaning that they could start to have so much cash that it is difficult to buy quality assets at a good price.

There is, I feel, something of a short-term squeeze going on. The beleaguered banks that own huge amounts of commercial property were expected to dump much of this on to the market in order to raise money.

However, the banks have behaved rationally for once and are biding their time. This means there is no great supply of property, and with foreign investors attracted to the UK by a weak pound and funds sitting on plenty of cash, there could be a rush to invest in commercial property.

The IPD Index that measures commercial property prices has just had its first positive month since the middle of 2007, rising by 0.2 per cent. Note, however, that commercial property should not be bought as some kind of short-term bet. I am suggesting that investors focus on the long term (by which I mean 5 to 10 years) and simply dip their toes in the water for now. A diversified portfolio probably shouldn't have more than about 2.5 per cent to 5 per cent at present.

One of the beauties of the Threadneedle fund is that it is quite small, which means it can buy into smaller properties where there is greater availability. Larger funds have to find much bigger premises to buy – a harder task. Threadneedle also has one of the sharpest property teams that I have met; I feel confident Don Jordison and his team can not only find good properties but also reliable tenants. So I am now moving my stance on the commercial property sector to a tentative buy for the first time in over six years.

Mark Dampier is the head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more information about the funds included in this column, visit www.h-l.co.uk/independent