Most of us have a good grasp of how property investments work. This comes through our experience of renting or buying our own homes – or even, in this Airbnb age, of renting out other properties. So it’s ironic, then, that most ordinary investors tend to neglect property investments in their pension portfolios, preferring to focus on stocks and bonds.
But the principles of investment in commercial property are straightforward, as are its attractions as an asset class. And in a period of rising interest rates and stretched valuations elsewhere, those attractions are particularly compelling today.
Perhaps the most appealing aspect of property is the regular income it can generally provide. Yields on UK commercial property are currently significantly higher than those available from bond and equity markets. And this income is remarkably steady – making it especially attractive at a time when stockmarket volatility is rising. With bond yields still extremely low by historical standards, property presents a prime source of regular income.
There are good reasons to expect the steady return profile of property to continue. While stocks and bonds can be sold in seconds, selling property can take months. But this lack of liquidity can be an asset for property investors – because it insulates them from the sort of panic selling that often sparks sharp sell-offs in security markets.
Market crashes can stem from sentiment as much as anything else. But because the sale of property assets can’t be achieved at the touch of a button, the prices of those assets are much steadier. That’s why the UK property market has been able to deliver steady, incremental growth in recent years – with only a fraction of the volatility of the stock and bond markets.
Property’s distinctive return profile offers significant diversification benefits. Professional investors have long been aware of these, but individual investors have been slow to catch on. Most ordinary investors have much smaller allocations to property than the professionals. And the diversification benefits of property aren’t only found in contrast to other asset classes. There’s plenty of scope for diversification within a property portfolio too.
Take the office sub-sector for example: although yields from London offices are not currently compelling, offices in other areas of the UK offer much better prospects for income. In the same way, retail warehouses allow investors to benefit from Britain’s changing shopping habits at a time when online competition is savaging the traditional high street.
Another crucial consideration with property is that your investment is backed by physical assets. That provides a level of resilience that you don’t get with financial securities. Yes, the property market can experience downturns like any other asset market. But those downturns are limited by the fact that land and buildings are finite commodities that will always have some value. A company may be superseded by its competitors – or ‘disrupted’ by technological innovations. And if a company goes bust, its shares are worthless. The same applies to bonds if a company defaults. But land will always have value. As the American humourist Will Rogers said, “they ain’t making any more of the stuff”. Property provides a degree of security that the security markets simply can’t match.
And because it’s a tangible asset, property also offers some built-in protection against inflation. Tenants naturally expect to pay higher rents at a time when wages and incomes are rising.
Also, leases for commercial tenants often contain upward only rent reviews or fixed rental increases: provisions to ensure that the income from the property rises over time.
Today, of course, we’re in an environment of rising bond yields, as central banks slowly normalise their monetary policy. If inflation continues to rise, the Bank of England will continue to raise interest rates to combat it. That’s a serious consideration for fixed-income securities; higher rates mean higher bond yields and lower bond prices. But it’s far less of a concern for the property sector, where borrowing is low and the relationship between interest rates and yields is much more complex.
In fact, it’s even possible that rising interest rates will restrict the supply of new property – making the existing stock more valuable. That’s because tighter monetary conditions will make it harder for developers to borrow. And with less cheap money in the system to fund the building of new property, demand will focus on what’s already there.
Finally, property provides significant opportunities to improve the quality of investments through direct asset management. An out-of-town shopping centre might be a good investment as it stands. But a skilled management team can make it a great investment through improving the facilities, attracting appropriate tenants and enhancing the experience for consumers. The prospect of adding significant value through the management of individual assets is something that sets property apart – making it an option that all forward-looking investors should consider.
Calum Bruce is investment manager at Ediston Property Investment Company