Property: another option for income investors

With interest rates still at record lows, and tapering in the US set to begin this month, the worries over bonds and rising yields leave income investors in a bit of a quandary: higher yields mean more income but could result in capital losses. So what other options do they have?

One option, I think, lies in commercial property funds. Returns from real estate are closely correlated with the health of the economy, so it's no surprise that returns from the sector have been muted since the great recession of 2008-2009. Indeed, commercial property capital values remain more than a third below their pre-recession peak.

However, the income element of the asset class has held up well. A number of commercial bricks and mortar funds are producing a yield of more than 4%, which is better than cash and compares favourably with both UK equities and benchmark 10-year gilts.

Couple this with the fact that the outlook for capital growth is now considerably more positive and it's looking quite an attractive investment.

According to Standard Life Investments, their UK real estate score card began to flash green in December, signalling renewed asset price growth. The UK is moving on to the next stage of the economic cycle and UK tenants are starting to take on more space. Rent and yield forecasts are rising.

The Ignis Real Estate team are very bullish and have gone as far as to predict 11.5% returns for the asset class this year – this may seem high but is actually just 2% more than consensus. The good news for income investors is that they believe this return will come from an equal combination of income and capital growth.

The sector also has diversification benefits, as it has a low correlation to equity markets. While questions are being raised about a London residential property bubble, elsewhere in the country commercial property is quite cheap and, as the economic recovery spreads and strengthens across the UK, the asset class should benefit.

M&G's Fiona Rowley agrees. She says that demand for office space is increasing in the South East and expected to spread to the 'big six': Manchester, Birmingham, Leeds, Bristol, Edinburgh and Glasgow.

Investors do need to be aware that this asset class can be illiquid though and funds have a history of having to suspend trading if there are more people wanting to redeem than buy. While suspending a fund like this is in the interest of underlying investors (so properties don't have to be sold at a discount to meet redemptions) that is often little consolation to people who want their cash. But for income investors looking to diversify their income stream further or find an alternative for some of their fixed income holdings, I think the sector is definitely worth a look this year.

By Darius McDermott, managing director, Chelsea

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested,and tax rules can change over time. Darius' views are his own and do not constitute financial advice.