Lease length
The lease length in the UK is longer than
in Europe or the US. The typical length of an office lease in London, for example, is between 10 and 15 years. The average length of office leases across the UK is around eight years.10
Residential properties generally have leases of 6-12 months. This means that investing in commercial property offers more security as you benefit from a set level of income for a specific (and long) period of time.
Direct commercial property investment
The risk is spread across several different properties that are directly owned by the investment fund. If one property is empty, and therefore not earning rent, others within the fund will still be generating income.
You will benefit from an annual return from rent, and when you cash in the investment, you can hope to get the sum you initially invested plus the growth in value of all the properties within the fund.
• Benefits
– Rental income can be secure when compared with other asset classes. This is due to the long lease lengths, and the fact that there is less risk of default than with residential properties. – Rental incomes will increase every year by at least the rate of inflation. – You don’t have to deal with property management, as the fund manager has to do that. It’s their responsibility to get tenants, negotiate lease lengths and invest in prime property.
• Risks
– Commercial property markets are slow moving. – Buying or selling property can take months, and fast access to your investment in the fund is unlikely. – There is a little-known lock out clause that can stop property fund investors getting their money out under ‘exceptional circumstances’. This caught a number of investors out during the financial crisis in 2007/8. The FCA rules that property funds are allowed to suspend trading for 28 days to sell properties and therefore raise enough cash to pay investors who want to reclaim their investment. They can repeat this 28 day stay of execution until they have enough money to pay out. This can last up to 12 months.
Indirect commercial property funds
Usually in the form of unit trusts and OEICs, these funds buy shares in property investment companies.
• Benefits
– As these shares are listed on the stock exchange and traded daily, they don’t have the liquidity problems mentioned above. Therefore, you can move funds in and out freely. – More than 80% of the property companies mentioned above are REITs and, as such, have more tax benefits than other listed property companies. – REITs don’t have to pay corporation tax on their assets as long as 90% of the profits are aid out to shareholders.
• Risks
– The volatility of investing on the stock market is always a risk.
Property investment trusts
These pool your money to buy property company shares and property.
The main difference between REITs and property investment trusts is that they’re treated like any other company. That means tax on dividends is 7.5% for Basic Rate payers on anything over £5,000, for the tax year 2016-2017.
Many property investment trusts use different strategies to boost the money they can put into a property beyond your investment. An example of this is ‘gearing’, which allows these companies to borrow money to boost the investment. This is good news in a rising market as you can gain more, but it can also increase losses. What should you be aware of?
If you’re considering investing in commercial property, then you need to be aware of:
• Diversification.
• Volatility.
• Liquidity.
While property funds can be less subject to volatility than other assets, direct property funds are less fluid. This is because you are trying to sell an actual, physical property. It can be particularly difficult to sell during a market crash.
There can be times where there are fewer buyers than sellers. In these cases, fund managers can switch from ‘offer’ (highest) to ‘mid’ or ‘bid’ pricing (lower), which reduces the value of the fund by around 6%. At worst, the fund can be closed so that no purchases or redemptions can take place.
Investors in commercial property funds must ensure they take a diversified approach. Holding a portfolio with a good and varied spread of industrial, office and retail can mitigate many sector-specific risks.
The ideal number of properties a fund should hold is around 40. Any fewer then the investor could be taking a bigger risk due to potential tenancy issues.
Location and how the property will be managed is extremely important when it comes to investing in commercial property. Ensure you are well advised to minimise risk.