Is it Time to Sell Out of UK Commercial Property?

After years of double digit returns the prospects for the UK commercial property market do not look as bright. We examine the role of property in your portfolio

Emma Wall 16 May, 2016 | 10:55AM
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Emma Wall: Hello and welcome to Morningstar Series ‘Ask the Expert’. I’m Emma Wall and I’m joined today by Morningstar Investment Management’s Simon Molica.

Hi, Simon.

Simon Molica: Hi, Emma.

Wall: So we’re here today to talk about U.K. commercial property, an incredibly popular asset class with our readers because of course it has being kicking off as very attractive yield in a very low yielding environment. It has done very well, what performance are we looking at?

Molica: Well, I think it’s important for us to remind ourselves what’s actually happened. So, if we think of the period of June 2007 to 2009, we saw quite a dramatic crash really, peak to trough 40% off, so that’s a lot in property. Generally, what we like from property is for it to be a yielding asset class and inflation protected. But given that supply and demand characteristics, can actually make it quite cyclical in nature. So we had a big crash, which actually meant after that period it was quite attractive.

So a very high yield, prices have fallen a lot. But actually what we’ve seen since then is a strong recovery, we really have. I mean, total return perspective very strong indeed and as you highlight a good yield as well now. And a lot of people have really gone into the sector, it’s being very popular and we’ve seen flows quite dramatically really rise in that area too.

Wall: 2014, 2015, we saw double-digit returns in the index and if you think about what the FTSE for example in over those two years, you can understand why flows have chased that performance. We’re at a position now though where we’ve thinking actually is that sustainable and you’ve taken the decision in one of your managed portfolios actually no longer to be exposed because you don’t think that kind of growth is sustainable to you.

Molica: Yeah, I mean, it’s a really interesting time for property. It’s being extremely strong as you say and I think there are some great risks out there with property and liquidity is one of the real risk that people need to be aware of. There has been a strong recovery, but you've got to question what the risks will be and we think of liquidity as being very important. So actually in this asset class we like to be quite cautious and we like to really exit quite early - as early as possible. The returns have been strong and the yield is still good. So actually in some investors, it’s still appropriate to maintain that asset class.

Wall: For those ones that have solely focused on income there you’re thinking.

Molica: Yeah, it’s a very good point. So at Morningstar we have a range, the income range, focused on sustainability of income. Now property deliveries you that, so actually being able to invest throughout the cycle makes sense for product. But in the active range, one of the co-managers of that range, we decided to exit and what we’ve really done over the last 12 months is being reducing our property exposure gradually. We don't think there’s going to be as much of a continued recovery in the capital valuation side of property and it’s now mostly the majority of that total return will come from income.

Now saying that we think the income will still be okay, yields are obviously less than what they were as yields have compressed when we’ve see the recovery. But you know, tenant demand and the occupation side, they’re still strong. Companies are willing to spend money, they’re willing to pay CapEx, they’re willing to pay up for rents. And that could drive a good income return, but as a kind of total return, then we just think actually we can’t what we’ve experienced over the last two years, it's unlikely to be that strong, which then leads us to think about what are the asset classes we can invest in over property.

Our property exposure has been incredibly high over the last two years. It’s been very overweighed and we’ve just taken the advantage to bring that down to neutral and actually more recently exited completely in the active range.

Wall: And that’s just saying because you can’t get better growth opportunities elsewhere.

Molica: Yeah, there is more attractive options elsewhere, equities probably look a little bit more attractive than they were, but we’re thinking about at six, nine months ago. But to be honest, absolute return is somewhere we’re actually putting a bit of capital as well. Because to be fair fixed income is quite expensive, equities are broadly around fair value.

Wall: And there’s a lot of uncertainty in the market.

Molica: There is, yeah. There is a lot of uncertainty, but actually someone has spoken about a lot at the moment and you know the uncertainty does cause issues and actually cashes somewhere we think is protect investors for the moment certainly, while with these issues get ironed out.

Wall: Simon, thank you very much.

Molica: Thank you, Emma.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Emma Wall  is former Senior International Editor for Morningstar