Most people, when they think of property, think of either residential estate agents or structural surveyors.
Few people think of commercial property as an investment (such as equities and bonds) and even fewer are aware of the depth of expertise which exists in the field of commercial property fund management and the opportunities for investors to participate in this kind of investment.
Commercial property has a number of distinctive positive characteristics.
Property is a tangible asset, unlike bonds or equities. So, if a tenant goes into receivership, you still own the land and building (protecting capital) while the property can also be re-let (protecting income).
It is an asset type which can be managed by the owner/manager to enhance value (through refurbishments and re-lettings). It has a relatively high and secure income stream. The average yield on institutional commercial property is around 7 per cent and the average lease length is around 16 years.
Added to the above, UK commercial property has a low correlation of returns with other UK asset types. It performs contra-cyclically both to bonds and equities. For example, in 1994, when commercial property produced a total return of around 12 per cent, equities produced a negative return of -12 per cent.
It therefore provides the perfect complement to equities and bonds in an investor's portfolio, especially during times of volatility.
UK commercial property has a low correlation with UK equities, an even lower correlation with UK index-linked gilts and a lower correlation still with standard UK gilts. Commercial property also has a low short-term correlation with property company shares, whose fortunes are more closely linked to movements in the equity market.
A further advantage is that commercial property has a lower level of volatility of returns than other asset types which, given the current volatility in equity and bond markets, makes it a potential consideration as a complementary or alternative investment.
As can be seen from the bar chart, over the 10-year period from 1989-1999, commercial property had a far lower level of volatility than UK equities and also, which would perhaps surprise many investors, a lower level of volatility than UK gilts.
It is true that during the 1990s, property did not perform well on a relative basis. So, what are the reasons for believing that property should be a part of an investor's portfolio for the new millennium?
During the late 1980s, the yield on commercial property was effectively down at levels close to that of UK equities, reflecting investor confidence that rental growth on property would be broadly comparable with dividend growth for the equity market.
At the same time, the yield on commercial property was 4-5 per cent below the yield on medium-dated gilts.
During the first three years of the 1990s, this situation was reversed. The beginning of the 1990s saw the start of the great bull run in UK gilts and equities.
During the period from 1990 to late 1999, yields on medium-dated gilts fell from around 12 per cent to 5.25 per cent and on UK equities from around 5 per cent to 2 per cent. During the same period, the yield on commercial property rose from about 6 per cent to 7 per cent.
Furthermore, commercial property is now providing an income return of around 4 per cent above UK equities and around 1.5 per cent over medium-dated UK gilts. This differential is one of the main rea-sons why commercial property currently looks attractive from both an absolute and relative viewpoint.
However, commercial property is not just producing an attractive income return, it is also currently in a period of sustained income growth. We are forecasting that income growth on commercial property over the next three years will be in the region of 4 per cent a year, representing real rental growth of around 1.5 per cent a year. Over the next three years, MFM's total property market return forecasts per annum are as follows:
Retail warehouses – 10.1 per cent.
In-town retail – 8.4 per cent.
Industrial – 11.4 per cent.
Office – 11.9 per cent.
All Property – 10.2 per cent.
There is a good case for property as a complementary or alternative investment to equities and bonds.
It has a number of different characteristics which make it a particularly attractive diversifier of risk.
During the 1990s, commercial property was negatively re-rated while bonds and equities were positively re-rated.
As a result, the yield and valuation basis of commercial property is currently attractive relative to equities and bonds.
MFM expects commercial property to outperform UK equities and bonds on a three-year view, with an anticipated total return of around 10.2 per cent a year.