From office blocks to shops: the smarter way into property

The British obsession with property has yielded handsome returns of late. House prices have soared over the past decade, while investors in commercial property have also made healthy profits.

Over the past 10 years, commercial property has outperformed UK shares and bonds. For instance, over the five years to the end of December 2005, the Investment Property Databank (IPD) index returned 85.8 per cent, compared to 11.6 per cent for the FTSE All Share or 33.6 per cent for bonds (FT Gilts index).

Even over the past year, when UK equities recaptured some of the limelight by delivering a blistering 22 per cent return, property was not far behind at 18.8 per cent, with bonds at a more subdued 7.4 per cent.

With its low volatility and ability to provide both income and capital growth, property remains tempting. In addition, as Paul Ilott of IFA Bates Investment Services points out, property has a low correlation to equities, gilts and cash, making it an excellent way to diversify risk in a portfolio.

On the downside, it seems that the real boom has been and gone. John Wilson, head of property at Britannic Asset Management, thinks shares now offer better value than commercial property. Nevertheless, the latter should still deliver double digit returns in 2006, he reckons.

While it is difficult to physically buy a shopping centre, warehouse or office block because of the high cost, there are many ways for investors to hold commercial property.

One route is to hold actual property shares, such as British Land, Brixton or Land Securities; another is to invest in a UK property fund, such as Aberdeen Property Share or Premier Pan European Property Shares.

A more popular option for private investors is a pooled fund that invests in a portfolio of UK-based bricks and mortar. Funds include Britannic UK Property and New Star Property. As of last year, these funds are now permitted holdings for tax-free individual savings accounts.

There are also several investment trusts that hold commercial property, including those offered by Scottish Widows, Standard Life and Invesco. Often based offshore, they avoid corporation tax and tend to yield around 5 per cent.

Further afield, Sarasin, Schroders and Fidelity have all launched global property funds. Typically, these funds will invest in the global Real Estate Investment Trust (Reit) market and other listed property shares, rather than direct property.

Justin Modray, an adviser at BestInvest, likes these as they diversify risk by offering exposure to more than one country's market. UK Reits will be available from January 2007.

Tim Cockerill, head of research at Rowan & Co Capital Management, says up to 20 per cent of a diversified portfolio should be in property. He favours investment trusts because of the tax advantages and high yields.

Cockerill's tips are Isis Property Trust, Standard Life Property Income and F&C Property. Modray prefers open-ended structures such as Swip Property, Norwich Property and New Star Property.

However, do not get too excited about property funds as ISA holdings. Returns from a UK-authorised property unit trust held in an ISA will be exactly the same as for an equity fund. That is, the income from a property fund will be treated as being paid after the deduction of 10 per cent tax on dividends, which cannot be reclaimed.

The main longer term tax benefit of holding a property fund within an ISA is the freedom from capital gains tax.

Phil Wagstaff, a managing director at New Star, says, "This allows investors to diversify their ISA portfolios to include direct commercial property, a key asset class. It rebalances an obvious inequity -- favourable tax treatment in cash, equities and bonds, but not property.

Routes into residential property

Chancellor Gordon Brown's U-turn on allowing residential property to be held within self invested pension plans (Sipps) disappointed many, but residential property funds still offer a way into this sector.

The chancellor said in last December's pre-budget report that, from April, people would not get tax breaks on buy-to-let properties within their pensions.There are, however, several funds investing in the residential property market that can be held in Sipps, according to Martin Dilke-Wing, investment director at Morgans Independent Advisers. These include:

* Curzon Capital City Living Ltd, which invests in city apartments and, through gearing, aims to more than double growth in the Halifax House Price index. No income is paid as this is used to finance the mortgage and operating costs. The minimum investment in the fund is £20,000.

* Schroders Residential Property unit trust ,which provides capital growth and income by buying into undervalued opportunities. The minimum investment is £38,000.

* Close Capital Appreciation Trust, which invests in retirement housing and has long- term capital growth through joint tenancy with the occupier. "Upon vacation of the property, CAT is entitled to the whole leasehold interest," says Dilke-Wing. Minimum investment is £5,000.

However, he believes demand for such funds within Sipps is low as people were keener on the idea of owning a second home to let while receiving tax breaks.

"Owning a physical property had more appeal. For those who are already homeowners, investing in a residential fund may not be a sensible move as it concentrates exposure to property prices rather than diversifying risk," he argues.