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Differences between commercial and residential property investing

Differences between commercial and residential property investing

Following the Investment Association’s (IA) decision to split its Property sector into separate UK Direct Property and Property Other sectors from 1 September 2018, what are the differences between investing in commercial and residential property?

From the EU referendum fallout and more trouble on the high street for retailers, to reports of house price falls and changes to tax treatment, investors have been given pause for thought when it comes to gaining exposure to property.

The outlook, as reported in mainstream media, isn’t very optimistic. 

And while nearly a third of UK investors and high net worths still consider property one of their main investments, according to recent research by Rathbone Investment Management, just 7 per cent plan to increase their property portfolio. 

But investors may be reading too much into events and headlines.

For example, the perception that prices are tumbling is being shaped by the falls in and around London.

At the same time, however, both house prices and rental rates in other areas of the UK are either continuing to grow or stabilising.

There can also be a tendency to conflate commercial and residential property.

While the two sectors share certain features, and each has its pros and cons, there are important differences too.

Liquidity issues

Both commercial and residential property have an important role to play in investment portfolios, offering diversification, low correlation with other asset classes and crucially with each other, and are sources of regular income. 

During times like these, when there is nervousness around the market but demand for income remains high, residential property investment offers particular value. 

We’ve seen before how liquidity can be affected when investors become more cautious about property.

In the commercial property market, liquidity concerns raise the prospect of investors being prevented from withdrawing money from open-ended property funds, with several blocking redemptions in the wake of the EU referendum two years ago.

A number of funds did likewise in 2008, as commercial property prices threatened to plummet. 

While liquidity risk is a fact of life for property investors, the simple fact of it being a larger, more active market makes it less of a concern for residential property investments.

The nature of residential property transactions supports the market’s liquidity, with a high number of relatively modest purchases by owner-occupiers, as opposed to the higher value, lower volume institutional sales in the commercial sector. For example, there have been over 100,000 transactions each month over the last year.

When an imbalance of supply and demand - with low housebuilding levels pushing house prices up - and a growing population are also factored in, you have a market where demand will remain resilient and relatively invulnerable to cyclical forces.

That imbalance has helped fuel demand for private rented property too, but it’s not the only driver.

We’re seeing a long-term structural move towards a greater acceptance of renting, due to reasons such as a changing jobs market, student debt, the length of time taken to save for a deposit and marriages later in life that require increased flexibility of housing and location.