Commercial property has consistently outperformed other asset classes, says Peter Roscrow, managing director of Close Property Management
With the weight of press coverage highlighting the ability of Sipps to invest in residential property funds, advisers may be forgiven for momentarily forgetting that one of the more attractive asset classes available to Sipp investors is commercial property.
In comparison to the other main asset classes, commercial property has provided the most stable returns in recent years (see graph), making it highly suitable as a pension investment. Looking ahead, the indicators are that this consistency of performance will continue.
Good track record
The Investment Property Databank (IPD) reports the average All Property Total Return per annum over the last 10 years at 12.8%, compared to 7.9% and 7.7% for equities and gilts respectively. Property was the top-performing asset class with a return of 18.3% in 2004.
While equities outperformed the commercial property sector in 2005, the total return of 19.1% represented the third consecutive year of double-digit returns, principally as a result of a significant decrease in yields. Furthermore, returns on property improved significantly in the final quarter of 2005, with a total return of 26.6% on an annualised basis for the quarter, which DTZ Tie Leung (DTZ), the property consultancy firm, attributed to the largest quarter yield movement since March 2003.
Following its recent resurgence, the equities market has proved to be the strongest performer over the past one and three years, delivering a return of 22.0% in 2005. However, this does not appear to have diluted the weight of money that is seeking to gain exposure to UK commercial property. Further, the recent turbulence in equities should serve as a reminder of its volatility.
According to a recent survey conducted by the Investment Property Forum, the average total property return forecast for 2006 is 11.2%, while the average total return forecast for the next five years is 7.7% per annum.
Property and Sipps
So, why is commercial property so good for Sipps? Well, the plethora of funds currently on the market means that you can choose your commercial property investment to match the investment objectives of your Sipp. If you are looking for income drawdown then there are several commercial property funds that offer a high yield - much better than you would get with equities or gilts. For example, the Close High Income Properties plc 'D' share has a target annual dividend of 6.5p.
Where income is not a requirement, you will find commercial property funds that focus on longer-term capital growth rather than income. Often such funds are formed as closed-ended limited partnerships with an exempt trust acting as a feeder fund for Sipps. Although they may be closed ended, which means investors would normally need to stay in the fund until the ultimate realisation of the fund assets, it is often possible to affect a sale through the sponsor or manager who will create a matched bargain facility.
Where's the money?
So what sectors of the commercial property market will outperform over the coming years? Over the past few years, retail property has outperformed both offices and industrials. This looks set to change over the coming years as consumer spending looks finally set to slow after a long bull run.
This is highlighted by the fact that the British Retail Consortium has just started a campaign to change the basis on which they structure leases with landlords. Consequently offices, which have had a steady return over the last few years, look to move into pole position. In particular I feel there are good growth prospects. Small courtyard office schemes that are well linked with motorway access are my hot tip for 2006/2007.
Industrial property has always been somewhat of a mixed bag. Large distribution warehouses often follow the rent and capital growth pattern of the retail sector. Secondary multi-tenanted estates have largely been the preserve of institutions because of their difficult management issues. However, it is the secondary estates where I feel there is maximum growth potential, with the added benefit of a diversity of tenant risk. When considering such investments it is important to look at the track record of the fund manager and their approach to active management before investing.
For those Sipps that have been recently established for relatively younger workers, there is now the opportunity to participate in commercial development activity. These trades such as speculative development, land assembly and dealing, provide a high risk/reward profile. Indeed, with the strong demand for completed developments it is probably about time that more investors move up the 'food chain' and take part in development activity. There are still very good profits to be made in this sector.
Finally, if you can't decide what sectors to invest in then why not leave it to the professionals and invest through a fund of funds structure? This offers further diversification through exposure to a range of property sectors.
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