No way out: The sky falls in on commercial property

Funds that looked as safe as houses are now sliding in value, and those seeking to escape must pay a penalty. Is all hope lost? asks Esther Shaw

For many investors who have piled into commercial property funds over the past few years, the dream is turning sour.

When the market was booming, these funds looked a sure-fire bet. "Investors saw them as the 'golden egg'," says Phil-ippa Gee of independent financial adviser (IFA) Torquil Clark. However, with the world economy slowing, the credit crunch in full swing and general worries over property after the collapse in house prices in the US, the value of commercial property investments is on the slide.

"Funds such as New Star have experienced a loss of almost 20 per cent in the past year," says Ms Gee.

Unsurprisingly, many investors want to bail out, but barriers have been put in their way. Penalties, normally ranging between 2 and 7 per cent of the value of the investment, are being imposed on those taking out their money.

Standard Life, Prudential, AXA and New Star are among those that have already applied a penalty, and a few weeks ago insurer Friends Provident went further and suspended redemptions on its £1.2bn property fund for six months. In effect, this means investors cannot get their cash back until the summer at the earliest.

A spokesman for Friends Provident says its decision "reflects the general sharp decline in investor demand for UK commercial property in 2007, brought about by the credit crunch.

"We were seeing a considerable increase in the number of redemptions, with people surrendering units or switching to other funds," he adds.

The crux of the issue for providers is liquidity, says Dean McCarthy from IFA Cobalt Capital. "There are problems if people start panicking and want to withdraw their cash, as that money is tied up in property," he explains. "But fund rules state that in times of poor liquidity, the manager can reserve the right to impose a time restriction or 'lock-in'.

"If investors took their money out, the fund would then be forced to sell property, probably at below market rate," he continues. "This would mean the existing investors would get penalised because of those pulling out. The lock-in is a move to try to put off the short-term profit hunters."

But not all are convinced by this argument. "For many people, it was a case of out of the with-profits frying pan and into the inferno of commercial property," says Peter McGahan at IFA Worldwide Financial Planning. "Property funds may have looked like a safe asset but they are not, and at a time like this when fund managers can lock in investors for six months, people should think about getting out."

Ms Gee at Torquil Clark is more optimistic, pointing out that while New Star's UK property fund has plummeted 20 per cent in the past year, over five years it has grown by 35 per cent.

"No one should take the last year as a demonstration of what will be achieved in this sector in the future," she says, adding that while returns are likely to be muted over the next few years, there is still a place for commercial property funds as part of a balanced investment portfolio.

"That there are currently reductions posted on these funds makes them a much more attractive proposition, and some people are looking to capitalise on that by investing now."