Investing In Commercial Property

February 17, 2014

At a time when cash savings are yielding negligible returns, many people are looking at investment funds as a way of making their money work for them. Commercial property, in particular, is predicted to deliver strong returns in the coming months. Obviously, none but the wealthiest individuals can buy a commercial property straight-out, so the way that most of us get exposure is through a collective investment fund which invests on behalf of its members.

Collective investment funds will invest money in one of two ways: directly or indirectly. Both spread the risk, although direct investment in bricks and mortar is less vulnerable to the whims of the market than indirect investment.

With direct (‘bricks and mortar’) investment funds, the returns come from the increased value of the properties, plus rental income. In the UK, the average lease on a commercial property is 8 years, and rents will typically increase at the same rate as inflation. Furthermore, commercial property tends not to be linked to assets such as cash, fixed income and bonds, meaning that a hiccup on the stock market shouldn’t affect their value. Investors don’t have the hassle of sourcing and managing the properties, nor do they have to find tenants or negotiate leases. It can take months to buy or sell a commercial property, however, which makes it difficult to redeem your holding at short notice.

That’s not to say it’s without risks. In 2008, commercial property prices fell by 44 per cent as the sub-prime mortgage crisis in the US triggered further crises around the world. In areas outside London, prices remain around 40 per cent lower than at their 2007 peak.

Indirect investment funds are usually set up as unit trusts and open-ended investment companies (OEICs). They trade shares in companies whose primary investment is property. The fund is managed, so members are protected from the pressure of decision-making and the fund manager is able to exploit the economies of scale to get better prices.

Both unit trusts and OEICs are open-ended, in other words there’s no limit to the number of units or shares that the fund manager can issue. If the demand for units increases they simply buy more property, and if an investor wishes to redeem their holding they sell them back to the fund. This can lead to problems, such as the fund manager having to sell assets at a low price, but it’s more user-friendly than buying and selling shares on the stock market.

The majority of open-ended funds are also real estate investment trusts. In essence, this means that they don’t pay corporation tax on assets, as long as they pay at least 90 per cent of profits to their shareholders. Dividends are taxed at either 20 or 40 per cent.

Closed-ended investment trusts differ in that a fixed number of shares are issued when they’re set up. These are subsequently bought and sold on the stock market. The fact that the fund manager doesn’t have to sell assets to buy back shares adds an element of stability that unit trusts and OEICs don’t enjoy. The tax on dividends is 10 per cent for basic rate payers and 32.5 per cent for those on a higher rate.

Commercial property prices are now recovering after the sub-prime mortgage crisis of 2008, and an increase in revenue from rents is expected as economic conditions improve. Furthermore, the recent lack of investment in property should increase the value of existing buildings.

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