Bond prices should benefit from further falls in interest rates but prices have already risen sharply and further cuts in base rates are probably already priced into the market. Meanwhile, interest rates on savings are in full retreat.
When professional fund managers get disenchanted with shares, fixed interest stocks and cash deposits they simply buy more commercial property, on the grounds that most lease agreements are signed for 15 years, rents are reviewed only every five years with no provision for rent reductions, and, if interest rates generally fall, the value of a portfolio of good class properties with few unlet sites will automatically rise.
Research shows that there is little correlation between commercial property and the returns on shares, bonds or cash, so commercial property is an ideal asset when the other standbys look shaky. According to a recent survey by the property valuers Richard Ellis shares have been the best performing asset class, including income and capital gains, in 13 of the last 29 years but property has been the best performer in 11 of those years and it has produced a negative total return before inflation in only three of those years, compared with six for shares.
In the year to the end of November, the average value of property portfolios showed a rate of return of 12.7 per cent a share. More than half of this came from rental income while the balance was from rising property values, as calculated by leading property valuers. In terms of income alone the average commercial property portfolio is now yielding 8 per cent a year compared with about 5 per cent on typical gilt-edged stocks, just over 3 per cent on the FT-SE All Share index and 2.9 per cent on the top 100 shares.
Few private investors can afford to buy an office, factory or even a shop, let alone a well-balanced portfolio of property including city centre offices, factories, high street shops, retail parks and out-of-town shopping centres. But they can buy property bonds from a dozen or more insurance companies such as Sun Life, Canada Life, Norwich Union and Allied Dunbar. Barclays Bank and Norwich Union also run specialised unit trusts that invest in commercial property. The minimum investments in most cases are around pounds 1,000 with a 5 per cent initial charge and an annual management charge of 1.5 per cent.
Property bonds are a form of insurance bond. The fund is liable for tax on rental income and capital gains within it and no dividends are paid. But standard rate taxpayers are exempt from tax when they realise their investments and top rate taxpayers can take up to 5 per cent of their investment annually and defer paying the tax for up to 20 years, by which time they may have retired and dropped back to the standard rate.
Property unit trusts have to keep at least 20 per cent of their assets in cash, or in the shares of property companies such as MEPC or British Land, which can be quickly sold to meet any rush of withdrawals. The trusts are not liable to tax on capital gains but investors are liable to income tax on dividends and potentially to capital gains if their disposals exceed the annual limits. Property unit trusts cannot be put into a tax-free PEP nor will they be eligible for inclusion in an Individual Savings Account when they go on sale next April.
Rental incomes on property portfolios can fall, especially if tenants of commercial property go bust and an oversupply of new properties develops as it did in 1991. James Tuckey, the chief executive of MEPC, sounded a cautionary note recently but last Monday British Land sounded quite optimistic and Richard Ellis's analyst, Angus McIntosh, is projecting a total return of almost 10 per cent in 1999, rising to double figures again in 2000. He points out that the proportion of empty office properties in central London is hovering at the 4 per cent mark, compared with 16 per cent in 1991.
David Aarons, senior partner of the David Aarons Partnership of independent financial advisers, says commercial property should be part of all investors' portfolios. His guide is available for pounds 3, to cover postage and packing, from Shelton House, High Street, Woburn Sands MK17 8SD.