Make money from property investment

If you think the market is at the start of a recovery, now could be a great time to invest in commercial property.

We Brits just love property. These days there are more buy-to-letters and amateur property developers than you can shake a stick at. Even if you're just a homeowner, I'm sure you're still ever-so-slightly obsessed with its changing value.

But residential housing isn't the only way to invest in property. Not so very long ago, commercial property such as retail units, offices and industrial warehousing, were also hugely popular.

Of course, your average individual investor didn't go about buying up office blocks! Instead, they were given the opportunity to put money in commercial property through property funds.

And some investors did very well out of it. Just take a look how the UK commercial property sector has performed over the last five years:

UK commercial property returns over the last five years

Source: Investment Property Databank, IPD UK Annual Property Index. *Including rental income and capital growth from retail, office, industrial and other properties.

Those who invested at the beginning of 2004 enjoyed three fantastic years of double-digit growth. But as the financial crisis began to unfold and investor confidence collapsed, the sector's good run came to an abrupt halt in 2007 when returns turned negative at -3.4%.

The situation was to worsen in 2008 with a dismal return of -22.1%. Still, putting that figure in context, the UK stock market fell by 29.9% over the same period.

Nevertheless, the commercial property bubble had well and truly burst.

Err...so what's all the fuss about then?

With pretty appalling returns last year and the year before, why on earth would investors consider piling back in now?

For the first time in 26 months, the IPD UK Monthly Index recorded a positive total return for the sector of 0.2% in August. Returns were even stronger in September at 1.8%.  

So has the tide turned at last? It's still very early days. It would be foolish to conclude much on the strength of two months data, but the signs are encouraging.

Should I jump in now?

Of course, any asset bought at a low price and sold at a high price will yield a profit. With that in mind, is there a case for jumping back into commercial property at what could be the start of a recovery?

If you're tempted my advice is this: don't get carried away. Think about these factors:

• The economy - We're in a recession and there are still significant challenges facing the UK and global economies.
• Sector returns - There are indications that commercial property returns are bottoming out, but that doesn't necessarily mean the sector is out of the woods yet.
• Demand - Falling tenant demand reduces capital values. Demand for commercial property is said to be weak but improving. It's swings and roundabouts where experts claim demand for office space is falling, but appears stronger for industrial properties.
• Yields - Yield is the rent paid on a property as a percentage of its value. Yields are at the highest level since the mid-1980s at around 8%. This is good news for investors looking for an income, but does not indicate good capital growth.
• Rent reviews - Many commercial rental contracts allow upward-only rent reviews. This is beneficial where a property has good quality tenants who are tied into a long lease.
• Vacancy rates - Vacancy rates are an issue, but the IPD reports that rates have fallen from a record high in June.
• Stability - Property companies have benefitted from the stabilisation of the financial sector earlier this year. The banks' willingness to lend to institutional investors - such as property funds and pension funds - appears to be increasing.

How do I invest in commercial property?

Small investors (that means you!) can gain exposure to commercial property through property funds where you'll pay a fund manager to invest in property on your behalf.

There are two types: direct property and property securities. Direct property funds actually invest in bricks and mortar and hold a portfolio of properties. This is the type I've been talking about so far.

The second type - property securities - invests in the shares of property companies. These funds are generally more volatile than those which only invest directly in bricks and mortar. In fact, while the UK commercial property sector fell 22.1% in 2008, property shares were down 46.6% over the same period (measured by the FTSE All Share Real Estate Index).

An increase in investor appetite has caused new property funds to pop up all over the place. According to the Real Estate Investment Trust Association (Reita), 30 new funds have joined the market in the last few months alone.

So there are plenty to choose from. But make sure you do your research and fully understand what you're investing in. After all, some managers mix bricks and mortar and more volatile property shares together in one fund. And find out where the fund has its geographical focus. Will it invest in the UK or globally or in specific regions?

A nasty catch

At this point it's important to mention a huge snag which could come up for investors in direct property funds. (Note this doesn't apply to property securities.)

There's usually a clause which could prevent you from getting your money out. This might apply where properties have to be sold off to meet a huge influx of investor withdrawals. Of course, selling a shopping centre or an office block isn't going to be a quick process.

In normal times this wouldn't happen, but it can and it has. For example, after the commercial property bubble burst, investors lost confidence and starting deserting funds in their droves. Some managers put delays in place on withdrawals which meant investors had to wait several months before they got their money back, or were able to move it into another fund.

The good news is that managers are starting to lift or reduce the delays. Remember this only happens in exceptional market conditions, but it's worth keeping in mind.

A final thought

At the beginning of 2007, property funds attracted record levels of investment from small investors. But they put their money in at the very top of the market and had already missed out on the stellar returns of previous years.

Now it looks like the sector could be on the road to recovery, it may be worth dipping a toe in the commercial property waters. Just make sure you don't dive all the way in. After all, this could be a false dawn.

Ask a question about investing in commercial property on our Q and A tool

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