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Commercial property is an attractive asset to own

Commercial property in London

Property has bond-like qualities, in that it represents a solid asset that produces an income via rents, where the yield rises as the price falls and vice-versa (provided the rental income doesn’t fall, of course).

Property also offers some of the rewards and risks of equities:

  • The opportunity to make long-term capital gains
  • The potential for income to rise over time, ahead of inflation

Bricks-and-mortar property offers some diversification away from equities.

It is also theoretically simple for experts to value, consisting of physical assets with a quantifiable replacement cost, compared with the murky world of equities, although this certainly doesn’t make property immune from wild fluctuations in value, as seen between 2006 and 2009.

While the expected rewards will be lower than with equities, on balance these traits make commercial property a core asset class in my book. It is particularly attractive to anyone seeking income.

Commercial property is also a core holding of asset allocation guru David Swenson (see my recent article on his Yale portfolio). So I’m in good company!

Investing in commercial property via REITs

Buying individual commercial properties is risky, and too costly for most of us.

That means buying through collective investments:

  • Commercial property funds
  • Stock market listed REITs (real-estate investment trusts)
  • Other kinds of property investment trusts
  • Exchange-traded funds that hold REITS and other property companies

David Swensen says Real Estate Investment Trusts (which include listed UK property giants like Land Securities) are the best way for private investors to hold commercial property. I agree.

He doesn’t like funds, partly because of the charges and potential lack of access to your money. I agree, again!

Buying commercial property via REITs

A REIT is a special kind of investment company, which is exempted from paying corporation tax by the Government, provided it passes through at least 90% of its income to shareholders as dividends.

In the UK most of the big old property companies like Land Securities and British Land have converted to REIT status in the past few years. Both of those companies hold a wide range of assets, and while at the time of writing they’ve been badly hit by the recession and valuation concerns, they can safely be considered proxies for the UK commercial property market.

To spread your money even further, you could look at the iShares UK Property ETF (IUKP), which holds around 40 property companies, although not in equal measure. The ETF is dominated by Land Securities, British Land and a couple of others, with smaller REITS and a smattering of developers making up the weight.

I think this ETF is the simplest, cheapest and most flexible way to get exposure to UK property.

Note that if you do decide to explore smaller REITS and other property companies, their business activities can vary quite a bit.

In particular, while property developers are obviously connected to the health of the property market, developers don’t perform like a traditional property investment, since their earnings are mainly generated through their profitable business activity rather than rents.

Buying a developer is therefore much more like buying shares in any other stock market listed company.

Any money you put into a developer should be considered as part of the equity allocation of your portfolio, rather than your property allocation.

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