Investing in commercial property

Commercial properties include such spaces as offices, industrial buildings, shopping malls, warehouses, retail parks, hotels, cinemas, and logistics buildings. Investing in commercial property can usually be considered as being a good diversifier in client portfolios.

One way investors can access this asset class is through buying open-ended property funds, which look to pool the money of investors together in order to invest directly in these kinds of properties. These funds seek to benefit from both the growth in capital values of these buildings and the income generated by the rents paid by the respective tenants.

The performance of the property market, however, is closely linked to the economy, therefore gaining more immediate access to your investment can be more difficult. It is for this reason, investing in commercial property via these funds has come under greater observation, being the focus of a long running review by the FCA.

We have observed the following trends in commercial property in recent years:

• Given the relationship between the asset class and the broader economy, commercial property is often impacted during recessions or periods of significant downturn. As these more difficult times tend to be accompanied by a loss of general confidence, rising levels of unemployment, and greater difficulty in accessing financing, it can result in a decline in property values and a slowdown in sales.
• In the US, rising interests have been negatively impacting the commercial property market with falling transactions, softer pricing, and lower demand for offices, following the increased adoption of flexible working post Covid.
• Investors have become more cautious, and as the cost of borrowing has risen, so has the cost of mortgages and loans, which has made life more difficult for both owners and potential buyers.
• In the UK, demand for commercial property has also decreased alongside the economic slowdown. Office space is causing the greatest concern, given the rise of the hybrid working model. Challenges are also being felt in older offices in peripheral locations, whereby the amount of empty space has climbed steadily since Covid.
• New buildings, top-end space, and those buildings in prime areas such as London’s West End, however, are still seeing demand, especially those which have environmental certifications.
• While city centres remain relatively popular, locations further out are struggling and there are big variations even in desirable areas, though this is very dependent on the age, quality, and location of the building.
• Many of the property funds have been in net outflows, and have been selling assets to meet these redemption requests. Though these outflows are slowing in some circumstances, given the FCA is likely to make daily pricing for these vehicles untenable, it is difficult to see how these funds have a long-term future in their current form. Sales are, however, taking place at market value and there is no evidence to suggest that “fire sales” are likely.
• The outlook within the sector is mixed. Industrial occupational properties are being favoured and there is the potential for a recovery to continue in leisure and buy-torent assets, such as student accommodation.
• The outlook for retail is also mixed, with some favourable growth expected in supermarkets and leisure facilities alongside ongoing weakness in shopping centres and high street shops.

In summary, the market for UK commercial property remains challenging as the higher interest rate environment provides a major headwind. We do not currently own physical commercial property funds in our portfolios because of both the rising cost of finance, which is historically accompanied by weakening prices, and the poor liquidity which could become problematic if the outlook for UK property gets even worse.

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