Pundits and property

Pundits (sorry, experts) have made their predictions for investment markets in 2014, which I find both amusing and frustrating. Trawling through the internet to gather as wide a view as possible, three overwhelming themes struck me.

First, all the predictions are for the stock market and the majority for the FTSE 100 in particular. Second, they are all exceptionally positive. And finally, they quote a figure for an index but not a total return figure, which would include dividends.

The majority of investors will have a fairly balanced portfolio in terms of asset classes (I hope they do anyway), so just limiting predictions to the stock market is a fairly pointless exercise. What about gilts, corporate bonds, property or a balanced portfolio as a whole?

The fact that all the predictions - or guesses - I have seen are positive does not surprise me. I believe that there is a natural bias to predict what you would like to happen and what you think your clients would like to hear.

The average prediction of five leading firms is for the FTSE 100 to reach 7,560 by the end of 2014. This is a 12 per cent increase on the 31 December 2013 closing figure of 6,749. However, with dividends running at roughly 4 per cent the total predicted increase, this amounts to a whopping 16 per cent in the year.

While this is possible, I think it is wildly over-optimistic. To make any sort of relevant prediction, we need to look at recent history, make a firm analysis of the present and finally look at the unknowns we are facing in the future.

This March marks five years since the FTSE hit its credit-crunch low. Assuming it stays where it is for the next month or so, the total return over that five-year period from that low point is 126 per cent - almost 20 per cent per annum compound, and roughly double the 10 per cent per annum that we would expect from equity over the long term.

Recovering economy

So where are we now? The FTSE is what we would call 'fairly valued' based on company earnings and on this basis we would expect 'normal' returns. The economy as a whole is recovering, unemployment is falling and both consumer and business confidence growing.

However, it is the unknowns that worry me. For instance, what about the withdrawal of worldwide stimulus (quantitative easing), what about the emerging market slowdown, and is China facing a credit crisis? All these lead me to believe that the FTSE will be subdued and total returns for the year will be closer to 8 per cent for 2014, half the average return quoted above.

I could not find a single prediction for the returns of commercial property as an asset class in the consumer financial press. This surprises me and I am going to make a bold prediction that commercial property will deliver the best risk-adjusted returns during 2014. The sector represents an incredible investment opportunity: rents are running at 6.2 per cent (IPD Index) and with void rates falling and the economy expanding, rental yields are likely to increase in the future.

Where else can you secure an income as high as this? With interest rates forecast to stay low for a considerable time yet, it is likely that investors will have to continue to accept a much lower yield.

However, let's assume I own a property worth £1m currently and yielding £70k per annum (7 per cent). Over time, investors bid up the price of property until the yield drops to 5 per cent. This will increase my property value to £1,400,000, a 40 per cent increase. The rent is still £70k but is now 5 per cent of the increased value.

If that happens over five years, my total rent is 7 per cent times five = 35 per cent, plus capital of 40 per cent, giving a total return of 75 per cent. I believe returns during 2014 will be in excess of 12 per cent for the IPD index and about 10 per cent for funds. In short, a better return than the FTSE for a fraction of the risk.

Instead of owning your own building though, you could take advantage of this sector by investing in a fund. Choose ones that have no borrowings and that own the buildings outright then the risk is comparatively low. If you are looking for an alternative to cash but don't want to invest more in stock markets, commercial property could be the answer you are looking for.

Colin Lawson is founder and managing partner of Equilibrium Asset Management

He writes a regular blog about wealth management for Private Client Adviser