Concrete & Steel vs Bricks & Mortar
Commercial property has never really enjoyed a fanatical following, but the combination of consistently strong returns and impressive capital growth is beginning to seduce investors across the country.
Looking back to the early 1980’s, the sector acquired the reputation of being staid and boring in comparison to the high flying equity markets, which were just about to embark on an incredible bull run.
Even the weightings in property of the Institutional Pension and Life Funds fell from a peak of over 20% in the late 1970’s to around 5% in the mid-1990’s. This was due partly to a bout of poor performance and the lack of transparency in the market.
But, the bursting of the dot.com bubble, some four years ago altered investors’ perceptions of risk and sent them scuttling back to inject some diversification into what was left of their portfolios.
Unlike other asset classes, commercial property is far less volatile. Unlike other asset classes, whose performance is at the mercy of rising interest rates and global economic sentiment, the commercial property sector derives most of its returns through rental income. Tenants may often occupy buildings with long leases for up to 25 years. These rents are usually charged on an upwards-only review every five years. This means that if market rents fall, then the amount charged will remain the same until the end of the agreement and as a consequence, provide the investor with added security.
The key to success, according to Roger Dossett, the newly appointed manager of the New Star Property Unit Trust, is to research the quality of tenants, before any agreements are signed. He is of the opinion that if one has good quality tenants, then that in itself can guarantee that rental money keeps flowing.
The enthusiasm for commercial property has also been boosted by the current obsession with the residential property market. It seems that barely a day goes by without some speculation that house prices are either poised to rocket or set to collapse. Albeit that in the last couple of weeks the news appears to indicate a slowdown.
Thankfully, the two sectors are not closely correlated. As house prices have shot up in the last two years, capital values of commercial property have remained fairly stable and are less likely to suffer a severe correction.
Although companies are investing more money and the numbers of unemployed has recently fallen to 1.41m, the benefits of the property sector are still overlooked by many investors.
Having said all that, there are a couple of dark clouds on the horizon. The first is the worrying prospect of legislation being introduced to outlaw the use of upward only rent review clauses in contracts. Marin Moore, the president of the British Property Federation (BPF), warns that any such proposals could have “unintended consequences” for investment, tenants, savers and even the government’s own regeneration plans.
The second big issue is the prospect of a Reits (Real Estates Trusts) structure being established in the UK, which will bring everyone in to line with the rest of the G7 countries. Although there are no formal definitions, as yet, the most common characteristics of Reits are tax transparency (no capital gains or corporation tax within the vehicle), closed ended (no redemptions via the manager and only periodic equity raising) and the capability to be listed, even though this is not necessary. Industry observers expect to hear more about these proposals in November.
Whatever happens, the world of property investment still has plenty of untapped potential. Small investors have an estimated £35bn of capital for property investment, but lack of the required knowledge or access to the market has prevented them from becoming involved. A client should always have a diversified portfolio and commercial property should not be seen as panacea to one’s woes. It is not a one way bet. Maybe a holding of between 5% and 15% would not be unreasonable. By far the best way for a small investor to get involved in the market is by use of a collective vehicle such as a unit trust/ OIEC. Property Funds are currently available just now. These are operated by most insurance companies and many unit trust managers. If you think you should have some commercial property in your portfolio, ask your independent financial adviser to carry out the research and provide you with options.
Back to article list