Investing in commercial property is back in fashion with some big institutions seeking higher returns. Should private investors follow suit?
Commercial property is notoriously cyclical as an asset class and is not for everyone. But investing in the right place at the right time can potentially produce long-term returns, although, of course, these cannot be guaranteed. With a tentative growth in confidence, this asset class is being pursued once again by those big investors looking to diversify their equity exposure but finding that bonds are failing to produce the returns they seek.
One of the first to make a move into commercial property was Norges Bank. It manages the NOK 4.3 trillion (€717 billion) Norwegian sovereign wealth fund: a product of the country’s formidable oil income.
Some five years ago, in January 2011, the Bank, along with the UK’s Crown Estate, took its first tentative step into real estate investment. Since this initial foray, Norges Bank has invested in commercial property in other locations worldwide and a number of sovereign wealth funds have followed its lead.
Norges Bank’s £452 million investment1 in central London entitled the bank to a quarter of the net revenue from the Crown Estate’s property portfolio in Regency Street, widely regarded as one of the most valuable in the country.
Long-term leases to West End retailers and City financial and professional services firms tend to generate stable returns. Coupled with strong capital growth potential, investments like these can produce the sort of ‘inflation-proof’ returns that institutions look for. So, what are the options for private investors interested in pursuing a similar strategy?
Buying a freehold office, shop or industrial unit can be an attractive option – provided you do your homework. The best buys in prime locations tend to be snapped up quickly by institutions and specialist investors. But it is still possible to obtain quality commercial property assets, often as a result of repossession, at a reasonable price.
The usual caveat applies though – buyer beware. Renovating commercial property to acceptable standards may require substantial expenditure. Experience of real estate investment – and its ups and downs – is an advantage, and be prepared to take a long-term view.
REITs are stock market-listed companies with portfolios of real estate such as hotels, shopping centres and even apartment blocks, all of which aim to generate an income. UK property investment players include self-storage specialist Big Yellow Group and shopping centre operators Hammerson. Buying shares in these companies can allow private investors to spread their risk while potentially benefiting from the trust’s property experience.
Like all listed and quoted stocks, the share price can rise or fall and dividends can come and go. One key characteristic of REITs, however, is that they must distribute at least 90% of their taxable income to their investors. REITs may be worth considering as a relatively straightforward route into commercial property if you are comfortable with the associated risks.
Open-ended funds are a type of co-owned fund that can continue to issue or redeem (i.e. cancel) shares according to investor appetite. While REITs are ‘closed-ended’ – meaning they only issue a stipulated number of shares – the pot of money an OPF has to invest in property will continue growing as more investors buy into the fund. Equally, it can diminish if investors withdraw cash from the fund. These funds cover different geographies and property types and, as ever, the value of the fund can go up or down.
The key challenge for private investors is to assess the fund manager’s performance and whether the level of risk versus any potential return fits comfortably into the risk-return characteristics of their portfolio.
In some cases you may be investing alongside very affluent and highly influential sovereign wealth funds, private equity firms or pension funds. But bear in mind that these highly sophisticated investors often have vast sums of money at their disposal – they can afford to take a hit or two if things don’t go according to plan.
Many established property investors had their fingers badly burned during the financial crisis and have since made important changes to their investment criteria. Horror stories of lock-ins that stopped investors exiting plummeting stocks as the market fell have pushed flexibility further up the agenda, with many investors only committing to invest providing there is an established and straightforward exit policy. Greater transparency – with regular and more granular updates from fund managers – is also important.
Private investors could adopt a similar approach. Ask yourself whether you are happy with your fund manager’s level of transparency. How often do they report to shareholders? How liquid is your fund – can you exit at any time or are there demanding lock-in terms?
Watching the big investors can be particularly valuable when the commercial property market fluctuates. If the institutions start to sell, maybe you should too. As ever it’s all about doing what you can to manage your exposure to risk in a way that is appropriate to your circumstances – and commercial property investment is no exception.
1. Commercial property investment in London hits six-year high, Gavin Jackson, Financial Times, 1/1/14
Any views expressed by Bank of Scotland Private Banking are our current in-house views as at September 2015 and should not be relied upon as fact and could be proved wrong. This article was prepared as at September 2015. The information and opinions may not be accurate after this date.
Past performance is not a reliable indicator of future performance. The value of investments and the income from them can fall as well as rise and cannot be guaranteed.
Bank of Scotland Private Banking assumes no responsibility for the content or any reliance upon the content of the third party websites detailed in this article.
Bank of Scotland plc. Registered office: The Mound, Edinburgh, EH1 1YZ. Registered in Scotland, no. SC327000. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority under number 169628.
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