Private investors put focus on UK commercial property

As more private investors look to diversify – including those moving away from buy-to-let – the commercial property sector is increasingly on their radar. But what does it look like, who owns it and how does it perform over the long term? The UK’s commercial property stock stretches to £883bn (figure updated to end 2016). That’s around 13% of the entire UK property market, estimated at £6,800bn, according to the most recent research available from the Investment Property Forum (IPF) – an individual members’ organisation for those operating in the UK property investment market. Within this, the value of UK commercial property held by investors is £486bn. As the pie chart below shows, this is made up predominantly of offices and retail, followed by industrial and the increasingly popular “alternatives” sector, comprising a highly diverse range of assets including hotels and restaurants, medical uses and student housing (see p34). Private rented housing is also likely to feature as a major ‘food group’ in future, says Will Robson, global head of real estate applied research at MSCI, which provides business intelligence to institutional investors, real estate owners, managers, brokers and occupiers worldwide. Overseas investors owned a staggering £139bn share of the UK commercial property market by the end of 2016, according to the IPF. The next‑biggest owners are institutions, collective investment schemes, listed property companies and unlisted property companies. Private investors make up the smallest share of the market, at £13bn. This is up from £8bn in 2003. A report by the IPF aimed at financial advisers outlines some of the pros and cons of direct property investment and the indirect investment route (such as buying shares in Real Estate Investment Trusts (REITS) or investing in collective property funds). So how does property perform as an investment? Returns Rent is a first charge on the assets of a company and therefore takes priority over many other forms of debt – although the recent spate of Company Voluntary Arrangements has highlighted the vulnerability of landlords in this regard (see p42). Data from MSCI shows the underlying relative consistency of property rental returns compared with the far more cyclical capital returns (see opposite). In other words, deciding when to buy or sell a property is key. Commercial leases are still relatively long term in the UK – averaging 7.1 years, according to the latest UK Lease Events Review, compiled by MSCI and sponsored by BNP Paribas Real Estate and the British Property Federation. And nearly all commercial lease contracts make provision for a review of the rent if the lease term is more than five years. Rents are usually reviewed to the level of the prevailing market at that time, supported by a provision that the change is based on upward-only reviews. However, UK occupiers have been negotiating shorter leases and more flexible long-term tenancy commitments in light of Brexit uncertainty and sluggish economic growth, the UK Lease Events Review showed (for the year to December 2017). It’s also worth noting here that MSCI’s property returns data is based on institutional-grade assets held predominantly in the fund management sphere. But, says Robson, the smaller sub-£5m stock accessible to direct investment by private investors (typically through the auction market) “does not perform completely differently – the overall trends are the same.” He adds: “Some of our clients sell through auction as a means of recycling assets.” Comparison with other asset classes The investment returns from property are usually compared with those from equity and bonds. In comparison with income from equities, property rent is generally much more predictable and certain, according to the IPF report. “People like the secure cash flows from property leases and tend to think of them as a little bit bond-like,” says Robson. “We would caution a bit against that – rents can go up and down.” Meanwhile, conventional bonds (except for those that are index-linked) provide an assured return but do not offer the prospect of income growth. Investors who are prepared to manage their portfolios actively can benefit significantly from periods of property outperformance compared with equities and bonds. “Through a financial crisis, property performs better than equities – it falls less far and on recovery it performs pretty well against equities,” says Robson. The cyclical nature of markets is clear when the total returns from property, equity and bonds are compared over the short, medium and long term: property outperformed the other two asset classes over three and five years to September 2017; but equity and bonds performed slightly better over the 10-year period. In terms of risk profile, property is usually regarded as being between bonds (lower risk) and equities (higher risk) but with the benefit of potential income growth from rental uplifts. However, as the IPF report stresses, liquidity risk should not be understated. Private investors have continued to invest strongly in commercial property in 2018, with a growing proportion invested through auction: of £1.6bn invested in H1 2018, £959m (60%) was through private treaty and £620m (40%) through auction (Property Data and EIG). Narrowing this to institutional investment assets, private investors bought £445m. At 28% of total investment, this is the highest percentage since 2011 (Acuitus/MSCI). Further reading: this article includes extracts from Understanding UK Commercial Property Investments: A Guide for Financial Advisers, 2017 Edition, which is available at www.ipf.org.uk and will be updated next year. To send feedback, e-mail julia.cahill@egi.co.uk or tweet @EGJuliaC or @estatesgazette