Differences between commercial and residential property investing

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by
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.

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

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. 

This steady demand helps deliver the kind of reliable, sustainable income that many investors crave.

The need to satisfy that demand is attracting a growing number of institutional investors to the market, recognising that residential property isn’t subject to the pressure that areas of the commercial property sector are under.

We’re in a low yield, low growth environment in which there is growing uncertainty about the outlook for markets, with indications that we’re nearing the end of the bull run that began in 2009.

Property is well positioned to provide long-term investors in particular with the diversification and income they need.

Residential property remains relatively peripheral as an asset class, but that will change as policymakers turn increasingly to private and institutional finance.

Property funds

Retail investors will have been familiar with the many funds offering commercial property as an asset class and seen housing through the lenses of buy-to-let and owner occupation, so they may well view residential property as presenting the same opportunities and risks. 

That’s not quite the case, however, and the different characteristics of each suggest that combining the two within multi-asset portfolios provides the potential for robust risk adjusted and uncorrelated returns.

By splitting bricks and mortar property funds from those that invest in property securities, the IA’s new property sectors should make it easier for investors and advisers to research different options.

However, even within the new UK Direct Property sector, there will be significant variation, with some funds investing across a range of commercial property types, while others target specialist sectors like residential property or student accommodation.

Understanding the composition of a fund is therefore crucial before making direct comparisons, even between bricks and mortar products.

Alan Collett is a fund manager at Hearthstone Investments