With increasing numbers of asset managers putting a freeze on withdrawals, what does the future hold for commercial property funds? Your Money takes a look

The property rollercoaster is entering a flat phase after several years of thrilling peaks. Many of the house price indices are forecasting minimal growth for the residential market and, by all accounts, the commercial property market is not faring any better. The credit crunch is having an impact throughout the financial services sector and companies struggling to meet soaring rents are just another party feeling the squeeze.

These unfavourable market conditions mean that commercial property funds are becoming less appealing as a form investment. There are two ways commercial property funds can invest money – directly and indirectly. In the first method, the fund physically buys the property and reaps the benefits of any yields. Indirect investment involves the fund buying shares of companies who own portfolios of property (the yield is the property rent expressed as a percentage of its value).

While there will always be companies who require office space and other commercial property, some high-profile ventures have not been successful as hoped. London landmark 30 St Mary Axe – more commonly known as the Gherkin – was apparently left with many vacant floors after previous owner and principal occupant Swiss Re was reportedly unable to sell spare office space before selling the building in 2007.

Proceed with caution

As a result of the volatile market, funds are starting to lock in their investors. Scottish Widows this week imposed a six-month delay on investors wanting to sell their stake in £2.1bn of property held in its life and pensions funds, to prevent it becoming a forced seller of its property holdings in a failing market. Insurance company Aegon announced last week that investors in its Scottish Equitable property fund may have to wait up to a year to get their money back, while Friends Provident introduced a six-month delay on redemptions from its property fund in December.

Since the end of November, a total of seven property managers have imposed such restrictions, affecting more than £10bn worth of assets and about 450,000 retail investors. Britain’s largest property company Land Securities sold £507m of its shops and offices in the final three months of 2007, bringing the total sold for the year to £2bn – more than twice its usual sales. Land Securities hinted there may be a light at the end of the tunnel towards the end of 2008, saying it would be ready to start buying in earnest later in the year to take advantage of a high volume of expected sales from property funds and highly geared private investors.

Property is an illiquid asset and is difficult to sell quickly. If such funds run into trouble and their investors want to sell up, they may not have enough in cash holdings (most especially property funds) to cover their redemptions.

There is no doubting that commercial property funds can prove a valuable form of investment at the right time, but the signs would suggest that now is not quite the appropriate juncture. Industry analysts don’t hold much hope of things improving in the immediate future. In the latest issue of Your Money, for example, two of our investment experts had harsh words for the sector. Pick up the magazine from the end of February to find out more.