Unlocking commercial property’s advantages
Commercial property has an important role as a less volatile way of spreading out risk
Amid the eurozone crisis, fiscal austerity in the UK and talk of a possible slowdown in China, it has been easy for big-picture investors to overlook the attractions of UK commercial property.
The table below shows the average annual returns, volatility and correlations between the International Property Databank (IPD) UK Property, FTSE 100 and UK Gilts All Stocks indices for the 20 years to December 2011.
Even though the FTSE 100 has produced lacklustre returns since the collapse of the dotcom boom, over the longer period it is ahead of commercial property and gilts. However, as with all investment returns, it is vital to compare the volatility of different assets. It is on this measure that property shows its real worth. It is much less volatile than the stockmarket and only slightly more volatile than gilts. Indeed, every percentage point of return is achieved with much less volatility.
Another plus point for property is that it can broaden out and diversify a multi-asset portfolio – as the degrees of correlation between stocks, gilts and UK property show. Property actually has negative correlation with gilts and hardly any correlation with the FTSE 100. By including an appropriate weighting in a portfolio, investors can improve the relationship between its risks, volatility and returns.
Property and property funds have some unique features that distinguish them from mainstream share and gilt funds. Commercial property is different from the equity market in one important respect: it is an illiquid asset. In other words, a property portfolio takes a long time to build and sell to realise the proceeds. There is no central marketplace or exchange to buy and sell property and to fix a continuous price. Often the values of transactions are not revealed if they are private and the valuation of a property portfolio or fund is determined by independent surveyors. This illiquidity can cause problems. Following the credit crunch in 2008 some property funds suffered a wave of redemptions as investors wanted their cash. Some funds had to limit redemptions because it took time for them to realise cash from the properties to pay out investors.
Of course, when buying any fund, the return will be determined by the skill and good fortune of the people in charge, the fund managers. It is up to them to build, redevelop, buy, negotiate and lease the underlying land and buildings. The managers of these funds are often qualified surveyors who have the skills and experience in managing this particular type of asset class. Not only is buying at the right price important but further value can be added once a property has been bought. The team can add value by upgrading and refurbishing property in order to increase rents.