Investors seek good day at the office

Simon Hildrey looks at the growing attractions of commercial developments as alternatives to pensions and buy-to-let houses

Property investment has taken over from pensions as the main form of retirement planning for thousands of people, boosted by the return to annualised double-digit growth in house prices this year.

But too much exposure to residential property can be dangerous, especially as some industry experts predict property prices could fall by 30 to 40 per cent over the next five years. Yet you don't need to shun bricks and mortar entirely in order to diversify your portfolio. Commercial property could be the answer: private investors pumped £1.6bn into the sector last year.

The income generated by commercial property is one of its main attractions. The average yield is 6.4 per cent, with industrial property producing between 7.75 and 8 per cent. Peter Roscrow, managing director of Close Property Management, says total returns are currently around 10 per cent.

Returns also tend to be less volatile than those generated by residential housing. Rents on commercial properties tend only to move upwards, and the leases can last up to 25 years compared with six months in the residential sector. Com-mercial tenants also foot the bills for their own repairs.

Of course, commercial property is not without its risks. It is not as liquid as other asset classes and investing directly is prohibitively expensive. To gain portfolio diversification through direct investment, you would need to own between 15 and 18 properties. However, it is still possible to invest in the sector - via an open-ended fund or investment trust. And the proposed introduction of a tax-efficient vehicle - real estate investment trusts (Reits) - may increase access.

The growing amount of cash being invested in commercial property has made life harder for fund managers. Mr Roscrow says there are "too many buyers chasing too few properties".

This increase in competition is pushing up capital values but reducing yields. Lower yields can pose problems for funds that have geared, or borrowed heavily against, their investments. "Funds with gearing will not make money if yields do not exceed the cost of the debt," Mr Roscrow adds.

Greater competition is also making it difficult for investors to find reasonably priced properties, as buyers are paying the full asking price. Andrew Hicks, manager of the New Star Property unit trust, which invests 20 per cent of its assets in listed company shares for liquidity requirements, says: "Two years ago, we bought one in three of the properties we bid for. Now it is one in every five."

Nevertheless, Mr Hicks argues, increased demand has not significantly pushed up prices but simply means that full asking prices are being met. In the first quarter of this year, he says, the average price rose by only 1.8 per cent. The retail sector is still the strongest, he adds, although he has recently started buying offices again after a gap of nearly three years as he thinks they have reached the bottom of their downward cycle.

Another way of investing in commercial property is through listed companies, which can outperform the general stock market. The Aberdeen Property Share fund, for example, has produced a 60.03 per cent return over the past five years, compared with a fall of 13.43 per cent in the FTSE All Share index.

Alex Ross, manager of the fund, focuses on smaller companies specialising in one of the three sub-sectors of retail, offices and industrials. This enables him to weight the exposure of the portfolio himself and provides greater flexibility.

While independent financial advisers (IFAs) believe commercial property can play a role in the portfolios of private investors, they tend to be cautious about the asset class.

"Look carefully at the type of commercial property you are investing in and the type of tenants," advises Amanda Davidson, partner at IFA Charcol Holden Meehan. "The government is obviously one of the safest tenants. Is the property only designed for one type of commercial activity, such as a factory? What if factories in that area close down?"

Investors must remember that the sector lacks liquidity, she adds. "If you need money, you may have to wait six months [to get your cash back] because it takes time to sell properties."

Darius McDermott, managing director of IFA Chelsea Financial Services, says investors should consider putting 10 per cent of their portfolios in commercial property as a long-term holding: "If you invest in commercial property for 10-20 years, you don't generally lose money."