Is it time to stop investing in commercial property?

If you're worried by the turmoil in the markets, James Daley has some advice

Investors in the commercial property sector have been suffering from a crisis of confidence over the past few months, rushing to cash in their investments after seeing sharp falls in their value.

To make matters worse, several of the country's largest funds have subsequently been forced to close their doors to withdrawals for three, six, or even 12 months – raising the state of panic amongst investors to even higher levels.

This week, it was the turn of Scottish Widows to impose a six-month delay on requests for withdrawals from its life and pensions commercial property funds, following in the footsteps of Scottish Equitable, who only days before had stopped some of its clients transferring out of their property funds for a whole year. Friends Provident has also imposed a six-month deferral period, and other pension providers may well follow.

Perhaps understandably, nothing gets investors more frenzied than being told that they can't do what they want with their own cash. However, in the case of commercial property funds, customers can take comfort in the fact that the deferral periods are nothing sinister. They have been put in place to protect the cooler-headed investors who are content to sit tight and watch the storm blow over.

Unlike equity or bond funds, property funds are not able to dispose of their assets at a moment's notice. While all property funds keep a proportion of their money invested in liquid assets – so they can return investors' money whenever they want it – these reserves have been depleted in recent months as large numbers of clients have attempted to cash in their investments at once.

As a result, the funds are now faced with the choice of either selling properties as quickly as possible – almost certainly guaranteeing they receive less than they are worth – or telling investors that they will have to wait for their money.

By taking the latter option, the funds preserve value for the clients who remain invested.

In the three cases that affect private investors so far – Friends Provident, Scottish Equitable and Scottish Widows – the vast majority of money held in the funds is part of people's pensions. As a result, they can't get their hands on it until they are past 55 anyway, and most will not cash in their pension until much later.

The remaining customers are generally those who hold property within life insurance funds, or unit-linked bonds, both of which are long-term contracts.

Darius McDermott of Chelsea Financial Services, the independent advisers, says long-term investors should all sit tight and not panic. "Why would you want to cash in at a 20 per cent loss?" he says. "Commercial property has already fallen a long way. Do I think it could continue falling? Yes, it could all get worse over the next six months, and you could lose another 5 per cent. But is it going to go down another 20 per cent? I don't think so."

If you've got more short-term savings invested in commercial property, however, it may be worth reviewing your portfolio. Large numbers of investors have put retail funds, such as those run by New Star and Norwich Union, into their ISAs over the past few years and Mark Dampier of Hargreaves Lansdown, the independent adviser and broker, says some now have far too much exposure to the asset class.

If you are likely to need to get your hands on any of your money within the next year, it may now be worth switching it out of property in case your fund also becomes subject to a deferral on withdrawals.

It's worth remembering, however, that due to pricing restrictions imposed on these funds at the moment, you will have to cash in your units at a significant discount, adding further to any losses you have made while invested in the fund. So, if you don't need to move your money, it makes sense not to.

McDermott says investors should typically have around 10 per cent of their total portfolio invested in property, to act as a diversifier. Given that its returns are uncorrelated with the equity and bond markets, it should provide some support for your portfolio when other parts of it are falling.

While commercial property was returning around 18 per cent a year between 2004 and 2006, McDermott points out that this was highly irregular, adding that the recent correction was only to be expected. Historically, the asset class has returned around 7 per cent a year – above cash and bonds, but less than equities.

Unless you're a sophisticated investor, it makes good sense to seek professional financial advice on where to invest your money.

To find an independent financial adviser in your area, visit www.unbiased.co.uk.