Most good financial advisers will tell you commercial property funds are an important part of any investment portfolio.
But what are commercial property funds? And what role do they play in the success and failure of a portfolio? This article will explain everything you need to know regarding these funds and how to avoid making mistakes when investing in them.
Let’s get started.
What are commercial property funds?
The commercial property fund is run by a fund manager who invests in bricks and mortar property of a commercial nature.
Warehouses, factories, offices, shops are all examples of these kinds of properties that are rented by businesses and pay quarterly rent on a fixed term. They provide a good yield (around 4%) and have been historically used in a portfolio of investments to help reduce the volatility and the risk of that portfolio.
Let's look at how this works.
A safeguard against volatility
Commercial property funds, like fixed-interest funds (Gilts, corporate bonds, high yielding bonds) do not move regularly in the same way as equity markets do. In fact, they have the lowest coloration to the stock market of any funds available.
This is good news for a portfolio. It means that if the stock market goes down, commercial property funds may be stable, or even rise.
Because of this they can act as a safeguard against volatility and are a great example of diversifying your portfolio. We discussed diversification and why it's important in a recent blog which you can read here.
But it’s also worth noting that as they are not always prone to the lows of the stock market, they also do not experience the highs in the same way either, so it’s important to find the right balance between both property funds and fixed income and equity funds in your portfolio.
Another thing about these funds is that they can sometimes be difficult to trade out of.
The suspending of commercial property funds
Commercial property funds can be illiquid. This means that there are times, such as now, where you will not be able to trade in or out of a property fund because its trading has been suspended.
So why does this happen?
During uncertain times it's difficult to accurately value a property. As all commercial property funds are valued on the rent as a return on investment, if the future of that rent comes into doubt, then trading must stop until it stabilises again and the properties can be valued fairly. It may also be that there are a lot of redemptions from the fund, so a manager briefly suspends training.
So when should you look to bring commercial property funds into your portfolio?
Typically, most of my clients have a mix of commercial property funds and fixed interest funds in their portfolio, as well as equities. Unless you are looking to take 100% equity risk, the most aggressive and risky kind of investment, then you would need them for diversification and to help reduce risk.
It's important to know the benefits of commercial property funds and how they can affect your portfolio but each individual is different and you will need to know which mix is right for your portfolio. That’s why I would always recommend speaking with a good independent adviser first to avoid any mistakes or misconceptions.
Let's look at some of these common misconceptions now so you can avoid them in the future.
Property shares vs commercial property funds
Being an independent advisor for over 30 years, I have seen many clients come to me with worries and misconceptions about property funds. Of course, it's normal to have worries so don't worry, here are a few of the most common ones explained to help you avoid them.
- Some clients assume that funds will be invested in residential properties. This is not the case. All property funds are invested in commercial properties and own the building themselves.
- It's important to differentiate between investing in property shares and the properties themselves. Some property funds are available that just invest in shares but they do not provide the same diversification, reduction in risk, and volatility because they are holding equities.
So if you are trying to diversify away from equity funds there is no point buying property shares.
Sometimes clients are unaware of which type of property fund they are buying and can be very disappointed when they see a big reduction in the value of a property fund. This would happen because it was a holding fund and they didn’t know, or were perhaps advised poorly.
This is why you should always speak to an independent adviser first. It's their job to research the funds, talk to the fund managers and advise clients accordingly and they can help you avoid making these big mistakes.
But there is nothing wrong with doing your own research too and if you are the curious, hands-on type here are a few useful pointers to remember:
A high cash holding isn’t good for the long term
Assessing the cash holding of a property fund is very important because if a client is looking to make a withdrawal and the fund doesn’t have enough money then the fund must sell a building.
And if you have ever tried to sell a property before, you will know it takes a long time. You could be waiting months before you actually receive your money.
This is why these funds normally have to keep a much higher level of cash. For example, most property funds would traditionally keep around 15% of the fund in cash for pay-outs should investors wish to make withdrawals
But this can cause a problem as a high cash holding isn’t good for the dividends the fund pays and the capital growth. If say 25% of the portfolio is in cash, it's not being invested in the building and it's not going to grow in capital value. This can impact your returns and income from the fund.
So it’s always worth looking at the cash holding of a property fund.
So, to recap, having commercial property funds is a crucial part of most investment portfolios (unless you like to live dangerously). They help reduce risk and volatility and typically make a good, consistent return from their fixed rates and rent pay-outs.
However, they can be an issue during times like these. When businesses have closed and buildings are empty you may find yourself unable to trade for some time in these markets.
Understanding the pros and cons of these funds and being able to avoid the common mistakes made when investing in them is always useful but as I always say, it’s worth having a quick chat with an independent adviser to get the best advice and avoid making any mistakes
I hope this has been useful and if you have anything else to add I’d love to hear from you. To find out more feel free to get in touch by emailing firstname.lastname@example.org.
The views expressed in this article are those of the author and do not constitute financial advice. Applewood Independent Ltd is authorised and regulated by the Financial Conduct Authority. For financial advice designed for you and your specific circumstances, please contact the author using the contact details provided in this article, or alternatively contact the Applewood Independent Ltd office on 01270 626555.
The value of property investments and income from them can go down as well as up and investors may not get back the amount originally invested.
As property is a specialist sector it can be volatile in adverse market conditions, there could be delays in realising the investment.