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Commercial Property

 

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Commercial Property Investment
Property has long fascinated private investors. Unlike many other types of investment, such as shares and bonds, property is a tangible asset: if you own a property – or a slice of one – you can go and see your investment. Bricks and mortar are just that – not ephemeral pieces of paper that could lose their value overnight. While property valuations can fluctuate, the property is still there. Many private investors feel that they understand property better than other assets, if only because they have the experience of buying their own homes. This, however, can be a dangerous assumption.

Major institutional investors, such as pension funds and life insurance companies, do not have the same view of property as most private investors. First, institutions make a sharp differentiation between commercial property and residential property. As a general rule, only commercial property is of interest to UK institutional investors. Residential property ownership is regarded as having much heavier administrative overheads than commercial property, as well as greater political and reputational risk.

Secondly, from the early 1980s to the turn of the millennium, property investment had been an unfashionable area for the institutions. In the 1980s and 1990s, institutional investors generally reduced their exposure to commercial property. For example, 20 years ago the average commercial property holding in pension funds was about 13% [a]. By 1999 the figure had fallen to just 4% [a], the same as the average cash holding. It was not so much that property was an unattractive asset category, rather it was that shares – both in the UK and overseas – seemed much more attractive. In the booming equity markets of the last two decades of the 20th century, what is now seen as the relatively stable performance of property was then viewed as just plain unexciting. Looking purely at annual returns, UK equities outperformed UK property in 15 of the final 20 years of the last century [b].

The institutions' stance towards property has changed considerably since stockmarkets took a turn for the worse after the technology bubble burst in 2000. Property has been rediscovered as an investment category in the wake of tumbling share prices. By the end of 2004, the average pension fund's property holding had risen to 7.0% [a]. Other factors have also helped to increase interest in property investment.

Historically low interest rates have made it possible for investors to fund their property purchases largely through borrowing: the rent received has often more than covered the interest payable. For those not wishing to borrow, the high income yield from property is a major attraction.

The government's proposals to introduce a new form of property investment vehicle to the UK, the Real Estate Investment Trust (REIT), have also raised the profile of the sector.

Whilst the proposals are moving through the consultation stage, it is believed that the assumed tax efficiency of REITs has the potential to broaden the range of investors in property and transform the property company sector of the stockmarket.

For both institutions and private investors, commercial property is now an investment category that cannot be ignored.

Sources: [a] The WM Company, [b] Investment Property Databank.
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