Private investors are being advised not to invest in commercial property funds following reports that the sector is likely to fall during the next two years. But for those who take a bearish view of the market, there are also opportunities to make money from a downturn.

This week, the Bank of England warned that commercial property was “particularly prone to further shocks”. It followed a prediction from the Royal Institution of Chartered Surveyors that commercial property prices would fall 5 per cent this year and next, limiting returns including income to just 3 per cent this year, and zero next year. Commercial property funds are already being affected and have just recorded their first fall in total returns in 15 years.

However, property hedge funds are thriving on the volatility. Property derivatives allow these funds to take short positions and so profit from falling prices.

For example, Iceberg Alternative Real Estate outperformed property funds and the average hedge fund in August. The fund’s manager, Stephen Ashworth, said this performance was due to the fund’s use of property equities, property derivatives and unlisted funds to take advantage of inefficiencies in the market.

The availability of derivatives linked to the Investment Property Databank commercial property index is now leading to more property hedge fund launches in the UK. New Star has set up a real estate hedge fund that will take a long/short strategy and invest in globally listed real estate. Portland Capital, a boutique fund-management group, has also raised £101m for a new global property hedge fund. Fortis, Sarasin Chiswell, and Dawnay Day are active in this area, too.

Some mainstream funds can take similar short positions. BlackRock Absolute Alpha, for example, currently has up to a fifth of its cash in long and short commercial property positions.

Another, more direct, way for investors to make money from a commercial property downturn is to spread-bet on the price of listed commercial property companies and funds. Tom Hougaard, chief market strategist at City Index, said that spread-betters cannot short commercial property indices such as the IPD but they can take “down bets” on property shares.

But for most investors, profiting from a commercial property downturn will be less important than avoiding losses on existing holdings.

Mark Dampier, investment director at advice firm Hargreaves Lansdown, fears that some private investors might have as much as half their portfolio in commercial property funds. With these funds down about 5 per cent this year and a “stodgy time” ahead, he expects they will underperform cash in the next few years. Hargreaves Lansdown stopped recommending property funds two to three months ago and “won’t buy it for the time being”, said Dampier.

Jason Britton, co-fund manager at T Bailey, a fund of funds investment firm, said: “The real question is when all the bad news has been priced in [to the sector] and when to get back in.”

For those who do not want to worry about timing, though, there is an alternative. The Capital Protected Commercial Property Plan from IAF Securities offers 100 per cent of any upside in IPD index returns over the next three and a half years – but with 100 per cent capital protection. “If people are nervous about commercial property they can gain exposure with capital protection,” explained George Moore, spokesman for IAF Securities. “Because of the short-term nature of the plan, it is not suitable for Peps and Isas but it is fine for most Sipps and pension investments.”

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