Should you invest in shops and offices?

We look at the pros and cons of investing in commercial property.

Most Brits are big fans of investing in bricks and mortar. That’s not a surprise when you look at how well house prices have done over the last 50 years. But does it make sense to invest in commercial property as well? If you own a house, do you really need to also invest in shops, offices and warehouses?

Well, many investment professionals would have recommended commercial property in the past, and they would probably have given four reasons:

-          Commercial property has proved to be a good ‘hedge’ against inflation. In other words, if prices are rising fast, you’d normally expect the value of commercial property to rise just as fast, if not faster.

-          Property isn’t as risky as the stock market. That’s because shops and offices are often let on long leases for 15 years or more. So unless the tenant goes bust, you should benefit from a reliable, long-term income stream.

-          Traditionally, commercial property hasn’t been well ‘correlated’ with other assets such as shares and bonds. In other words, if the stock market fell by 20%, you wouldn’t normally expect commercial property to fall by as much. So including commercial property in your portfolio can reduce your overall level of risk.

-          Performance over the long-term has been pretty good. Look at this table:

Investment performance – total returns 1980 to 2010

Source: Legal & General/Investment Property Databank (IPD)

And when you look at the current market, the demand for offices in London is buoyant, especially the West End. Owners are also able to charge high rents at key retail developments such as Birmingham’s Bullring and Westfield in London.

So on the basis of what I’ve said so far, investing in commercial property sounds like a no-brainer, right?

Trouble is, things are changing. For starters, lots of commercial properties aren’t being let on such long leases any more. Now the lease might only be for five or seven years and there could be a ‘break clause’ which allows the tenant to scarper half way through. Changes to accounting rules will encourage property companies to switch more of their estates to short-term leases.

What’s more, commercial property has become more ‘correlated’ with the stock market. As share prices tumbled during the recent financial crisis, the value of commercial property fell a fair bit too.

The banks are another problem. As we all know, they’re much weaker than they used to be and they’ve got less money to lend to businesses that want to buy property. In fact, they’ll want to sell some of their property loans. Reduced lending will mean lower prices.

Then there’s the internet. Home working looks set to increase and the retail sector has been hit by the rise of online shopping. In fact, the health of the traditional high street is very frail these days – partly down to the web and partly due to new out-of-town shopping developments.

A sluggish economy won't help either.

Given these issues, I don’t think that commercial property is as attractive an investment as it was ten years ago. But if you’re saving for the long-term or you have control over your pension investments, I would still put a bit of money into commercial property. Valuations don't look too stretched, there's plenty of demand for office space in the City of London, and, let's not forget, offices and shops will remain a significant part of our economy for many years to come.

How to do it

So how can you invest in commercial property?

For ordinary folk, the two simplest ways are either via a unit trust or through one of the large property companies now known as REITs (real estate investment trusts.)  Well-known REITs include Land Securities and British Land. Buying shares in one of these companies is a cheap and simple way to invest in property.

That said, if the value of commercial property falls by 10%, you’d normally expect the share prices of REITs to fall by more than that – that’s because the REITs normally borrow to fund some of their investments. Borrowing magnifies gains when the going is good but it boosts losses too. Remember also that company directors can make bad investment decisions.

Unit trusts have been popular in the past but beware you may not be able to get your money back quickly if property prices start to fall fast. It takes time for a trust to sell properties so if lots of investors want their money back at the same time, they may be forced to wait for some time. Find out more in Make money from property investment.

So that’s the lowdown on investing in commercial property. If you decide to take the plunge, good luck!

More: Is property still profitable?  | Why property is profitable