We all know Britain is a nation of property lovers. But what do we know about buying and investing in commercial property?
In 2008, commercial property prices fell by an unprecedented 44 per cent almost overnight when the US sub-prime mortgage crisis hit and it’s only recently that we see prices outside of London starting to regain their lost ground.
Since the banking crisis in 2007, the market has gradually regained confidence and is becoming an increasingly attractive investment again.
Experts point out that while the price of property, in such as London, have mostly recovered, but there could still be value in the other outer areas, with good potential rental incomes and capital growth.
The commercial property market consists of shops, industrial buildings, warehouses and offices. You can typically invest directly by investing in a fund which holds actual physical property in its portfolio or by buying a property yourself, or indirectly by investing in funds exposed to property companies, developers and house builders, for example a Real Estate Investment Trust (REIT).
‘Direct’ property investment funds or trusts buy these units, whether new or existing and rent them out to other businesses on long leases, making a profit from the rental income as well as capital growth in the price of the property. This makes them popular with income seekers, as rental income typically rises in line with inflation.
Many investors invest in commercial property via a collective investment scheme. Property funds on the whole are a cheap and easy way to gain exposure to commercial property as an asset class.
Investment funds and trusts providing entry into this commercial sector are divided into two types. A traditional bricks and mortar fund will invest in the property directly and is structured as an open-ended fund or a closed-end investment trust. This fund will physically buy the property and be responsible for its maintenance and rent collection as well as having the added benefit of a regular rental income. However, as offices and warehouses are not easily bought or sold, the liquidity can be very slow. The second type is a property securities fund which invests in the shares of listed property companies and therefore is much more liquid, but is exposed to the ups and downs of the stock market.
Investors can also buy shares directly in a REIT (Real Estate Investment Trust), which runs a portfolio of properties, although this is a far less diverse way to invest as it’s just one company. Those with plenty of capital can also buy a property outright and lease it back to companies themselves, although this is without question a labour and capital-intensive, not to mention risky, way to gain access to the sector.
What to look out for
A large risk in the commercial property sector is finding tenants for empty buildings and recently we have seen the market split into two categories of property in good-quality locations, which continues to be investable and those properties in poorer, secondary locations that are often un-fundable and provide a poor return.
Property investors should be wary of three key areas: volatility, diversification and liquidity. On the upside, property funds can be less volatile than those focused on other assets, but direct property funds in particular are much less liquid because you are selling an actual property. It can be especially hard to sell when the property market is in decline. Also note that open-ended funds are particularly sticky because the fund manager has to cash in units, meaning selling property. Closed ended funds like investment trusts are more liquid because you just need to sell the shares in the trust, not the underlying assets.
Investors should ensure they take a well-diversified approach, by having a good spread of properties across retail, office and industrial. The main disadvantage of commercial property is that the location and management of the property is ‘everything’. Get this wrong and commercial property can be unforgiving. It’s also worth remembering that commercial property funds can be slightly more expensive than funds invested in other assets.