Commercial property investors see more short term pain as market nears bottom

Commercial property investors received another battering as a raft of bearish forecasts and store closures poured more gloom on the retail sector.

As the numbers of retailers closing their doors, moved from a trickle to a steady flow, store closures were forecast to rise by 27,000 by the end of February, leaving one in 10 outlets across the UK empty.

Experian, the market analysts, says a combination of store disposals, administrations and branch rationalisations would see the vacancy rate jump from 7% to 15% by the end of the year, a record level.

Meanwhile, property consultants King Sturge forecasts that commercial property values could fall a further 15% in 2009, after a 25% drop in 2008. Office space will be the hardest hit, says King Sturge, suffering a 50% drop in value from its peak, followed by retail at 40% and industrials at 35%.

The sector's downturn has hit the performance of UK commercial property funds, with the average fund in the Investment Management Association (IMA) Property Sector recording a 30% loss in the past 12 months, according to Lipper.

This has affected sentiment, with retail investors taking a net £117m out of property funds in October, according to the IMA.

But some are bravìng the gloom . Fidelity International claims that the next 18 months "will offer the best opportunity to acquire commercial real estate in a generation". Its veteran stock picker, Anthony Bolton, said in early December that although capital values still had a long way to fall, sector yields, which were about 6.5% at the time, were "attractive".

"Instead of cutting their losses, current investors should sit tight and take a medium to long-term view as we believe there will be a turnround in the next 12 to 18 months," says Gavin Haynes, investment manager with Whitechurch Securities, the financial advisers.

One of the sector's biggest funds, Aviva's £1.9billion Investors Property Investment, formerly the Norwich Property Trust, expects more pain in the short term, but says prospects are very favourable over the long term. "We see 2009 as a good opportunity, if not an unprecedented opportunity, to buy at exceptional value," says David Skinner, strategy and research director with Aviva Investors.

Skinner says gross initial yields for the sector are likely to have risen to about 7% since Bolton's comments.

But some advise against a hasty return to commercial property funds. "It might be tempting to improve yield, but it's too soon to move back," says Mark Dampier, investment director with Hargreaves Lansdown. "Anything that requires credit is going to have a hard time and we are going to see more spaces for rent and more defaults."

Brian Dennehy, managing director of Dennehy Weller, agrees that it is "too early" to return to equity-based investments in property and expects a recovery won't be felt uniformly. "Those funds more closely correlated with the stock market, such as Reits, are more likely to pick up sooner, compared with funds that invest directly in bricks and mortar," he argues. "Property share funds have taken a bigger battering, but the way the cycle works, they will bounce back much faster and further than bricks and mortar."

Although this week's forecasts have shed more gloom, some fund managers say they won't be making drastic changes to their portfolios.

"The way to get through this is not to juggle allocation and jump from retail to office and back," says Don Jordison, joint manager of Threadneedle's £32million UK Property Fund, which has held 55% in cash for the past 12 months and is one of the sector's best performers. "Our strategy has been to diversify from risk. We don't invest in trophy assets, and avoid property developments."

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