Property Investment

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Commercial Property

Commercial properties are usually divided into three main categories, in order of size and value:

  • Retail property – warehouses, high street shops, shopping centres, supermarkets and department stores.
  • Office property – office buildings and business parks.
  • Industrial property – the smallest category by value, covering industrial estates and distribution warehouses.

There are some exceptions to these categories, which include properties in the leisure sector such as hotels, pubs and cinemas.

To invest successfully in commercial property requires as much skill and expertise as investment in the stockmarket. In addition to an understanding of the risks involved, both require an assessment of the current and future condition of the economy, as well as its potential impact on the company or property being considered for investment. For example, a sharp rise in short-term interest rates will undoubtedly affect consumer spending, therefore reducing the investment appeal of shops and other retail property.

Investors should also take other factors in to consideration, such as location, the lease terms and making sure the property is suitable for the use to which it is put. Additionally, investment in property is not just a matter of making purchases then sitting back and collecting rents until the lease expires. To maximise returns, investors need to take an active approach to property management. For example, refurbishment, change of planning use and a renegotiation of lease terms can all add to the overall return from a property.

Why invest in commercial property?

One of the most widely accepted principles of investment is that diversification reduces your risk. There are a variety of reasons why private investors should consider commercial property as part of their overall investment portfolio.

Income yield

Regular reviews mean that property rent can keep pace with inflation. This process takes account of rents on similar properties. Additionally, where existing leases are being extended, upward only rent review provisions stop rents falling to market levels on the extended lease. General market conditions will also have an impact. In the early '90s for example, rents for new tenants fell significantly below those paid by existing tenants.

Diversification

One of the most widely accepted principles of investment is that diversification reduces your risk. In the context of shares, this means that you should hold a broad spread of shares across the main market sectors. A range of holdings – as provided by a unit trust – will mean that if one company fails, you do not lose all your money. But you will still not be immune from a general decline in stockmarket values, as happened between the start of the new millennium and early 2003.

This is where diversification across investment classes plays an important role.

The market cycle for commercial property is not closely linked with that of bonds or shares. According to research by some of the leading investment banks, over the period 1970-2002, there was only a limited correlation between the performance of commercial property and that of UK shares and gilts. Gilts were much more closely correlated with UK shares than property to shares or property to gilts.

Volatility

Returns from commercial property investments have been much less volatile compared to those from investment in shares. Part of the reason for this is the high level of income, which makes property investment similar in some respects to investment in fixed interest securities.

Yield calculations

Rental yield is one of the most commonly quoted yardsticks for comparing property investments. At its simplest, yield is calculated as Rental income/Property value x 100%

So, for example, if an office property is worth £15,000,000 and has rental income of £900,000, its yield is calculated as: £900,000/£15,000,000 x 100% = 6%

A property's yield can vary as a result of a change in the rental income and/or the property value. For example, if the rent on the office property increased to £1,200,000, the yield would rise to 8%. For its yield to stay at 6% with the higher rent, the property's value would have to rise to £20,000,000.

Commercial property can offer the benefits of regular income and potential capital growth together with healthy diversification. To find out more, contact a qualified Holborn Assets adviser today.