Why invest in commercial property?
Commercial property is an asset class to consider as a way of spreading, or diversifying, risk in your investment portfolio.
You can earn money from a commercial property investment through income from renting to a tenant or capital growth from an increase in the value of the property.
Generally, property isn't highly correlated to other assets classes such as cash, fixed income (bonds and gilts) and equities, meaning that property values move independently of other assets and aren't typically affected by what's going on in the stock markets.
If you're looking for information about residential property investing, you can read our guides on buy-to-let mortgages and more.
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How to invest in commercial property
There are three categories of commercial property:
- retail property - including shopping centres, supermarkets, retail warehouses and high street shops
- office property - purpose-built for businesses, these often require installation of high-speed internet and other services essential to businesses
- industrial property - such as industrial estates and warehouses
There are a number of different ways to get exposure to these types of property as an investment.
For private investors, direct investment in property means literally buying all of, or a share in, a property. For most people, this is not a practical way of getting exposure to the commercial property market.
Otherwise, you could invest in either direct or indirect property funds.
Investing in commercial property funds
Many property investors prefer the familiarity of investing directly in residential property, but commercial property can offer a simpler and lower-cost alternative.
Commercial properties cost millions of pounds to purchase or build and can command huge rental incomes but, in most cases, they're impossible for smaller investors to buy outright.
Therefore, most invest in commercial property through investment funds, like unit trusts, Oeics or investment trusts. You can find out more about these products in our different types of investment guide.
These funds either directly own properties and pay you returns based on their growth in value and rental income, or buy shares in property-related companies, paying you returns based on the growth in the value of the shares and the payment of dividends.
You usually only need around £500 to invest a lump sum in a property fund, or £50 per month for regular savings.
- Find out more:Investment funds explained
What are direct or 'bricks-and-mortar' commercial property funds?
Bricks-and-mortar funds refer to direct commercial property investment, meaning that actual physical properties are bought by the fund.
Risk is spread across a number of different properties and, therefore, if one property is not occupied (and therefore earning no income from rent), others within the fund can generate income. Your returns come from a combination of increased value of the properties in the fund and the rental income.
Rental income provides you with an annual return and, when you cash in your investment, you'll hopefully receive the sum you initially invested, plus any growth in value of the properties within the fund. Though the value could also have decreased from your initial investment.
Pros:
- Long lease lengths (typically five years or more), less risk of default than residential properties, and upward-only rent reviews, mean that rental income increases by at least inflation each year
- You don't have the hassle of finding locations, negotiation of property management, which falls to the manager of your fund
Cons:
- Unoccupied buildings still cost money to manage
- Property markets are highly illiquid compared with most other financial markets, meaning that buying or selling property can take months, and can make it difficult to sell your holding in the fund quickly
Warning
Beware the freezing of direct commercial property investment funds
In recent years a large number of direct property fund investors found they could not take their money out as property values plunged.
This was because property funds have a little-known clause that allows fund managers to shut off payments to investors wanting to exit the funds if there are "exceptional circ*mstances."
Under Financial Conduct Authority rules, property funds can suspend trading for 28 days while they try to raise enough cash by selling properties to meet the repayments of investors looking to reclaim their cash.
Long-term asset funds (LTAFs)
Long-term asset funds are a recently authorised open-ended investment fund aimed at getting more individual investors into less liquid private markets - including commercial property.
In the 2023 Autumn Statement, Chancellor Jeremy Hunt announced the inclusion of LTAFs within innovative finance Isas (Ifisas).
What are indirect commercial property funds?
These funds, usually in the form of unit trusts and Oeics, buy shares in companies that invest in property.
These shares are listed on the stock exchange and traded on a daily basis; therefore, they don't have the liquidity problems of direct commercial property funds, meaning you can move in and out of the fund freely.
Returns are gained like any other investment in shares, through share-price appreciation and dividend income, rather than directly through property price increases and rental income.
But while you get the benefit of the liquidity of an equity-like product, you also get the volatility of investing on the stock market.
Real estate investment trusts
The great majority (over 80%) of these property companies are known as Real Estate Investment Trusts (REITs) and have greater tax benefits than other listed property companies.
REIT companies don't pay corporation tax on their assets on the condition that 90% of profits are paid to shareholders as dividends, which, in turn, could mean higher payouts. REIT investors pay either 20% or 40% tax, because they're classed as property-letting income.
Property investment trusts
Alternatively, you could invest in property investment trusts, which will pool your money to buy property and property company shares.
The difference between these and REITs is that they're considered to be like any other company, so tax on dividends for the 2023-24 tax year is 8.75% for basic-rate taxpayers on any dividends over £1,000. This increases to 33.75% and 39.35% for higher and additional rate taxpayers respectively.
Investment trusts can do things that unit trusts and OEICs can't. For example, many property investment trusts use gearing - a process whereby the companies borrow money - to boost the amount they can put into property beyond what you have invested.
While this can enhance gains in a rising market, it can magnify losses if returns fall.
- Find out more:Investment trusts explained
