Commercial property investment Commercial property funds

Commercial property funds

Commercial property funds allow small investors to become part owners of huge properties

There are two different types of commercial property funds within which you can invest. They both come with different benefits and risks.

Direct or 'bricks and mortar' commercial property funds

Bricks and mortar funds refer to direct commercial property investment, meaning that actual physical properties are bought by the fund. Risk is spread across a number of different properties and, therefore, if one property is not occupied (and therefore earning no income from rent), others within the fund can generate income.

Your returns come from a combination of increased value of the properties in the fund and, more importantly, the rental income. Rental income provides you with an annual return, and when you cash in your investment, you'll hopefully receive the sum you initially invested, plus any growth in value of the properties within the fund.

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Benefits and risks of direct commercial property investment funds

With direct property funds, rental income can be relatively secure in comparison to other asset classes because of factors like long lease lengths (typically five years or more), less risk of default than residential properties and upward-only rent reviews, meaning that rental income increases by at least inflation each year.

You also don't have the hassle of property management, which falls to the manager of your fund. It's the manager's responsibility to source tenants, invest in property in prime locations and negotiate lease lengths.

A major downside of direct investment, however, is that property markets are highly illiquid compared to most other financial markets, meaning that buying or selling property can take months, and can make it difficult to sell your holding in the fund quickly.

Beware the lock-out of direct commercial property investment funds

When the financial crisis rocked the economy, a large number of direct property fund investors found they could not take their money out as property values plunged. This was because property funds have a little known clause that allows fund managers to shut off payments to investors wanting to exit the funds if there are "exceptional circumstances."

Under FCA rules, property funds can suspend trading for 28 days while they try to raise enough cash by selling properties to meet the repayments of investors looking to reclaim their cash. This 28-day period can recur until the fund has enough capital to meet redemptions and during the financial crisis of 2007/08, some of moratorium on people leaving funds lasted as long as 12 months. 

Fund managers argued this was for the benefit of investors, as a fire-sale of properties in such conditions would mean they would not be able to realise their full value.

Indirect commercial property funds

These funds, usually in the form of unit trusts and Oeics, buy shares in companies that invest in property. These shares are listed on the Stock Exchange and traded on a daily basis and, therefore, don't have the liquidity problems of direct commercial property funds, meaning you can move in and out of the fund freely.

Returns are gained like any other investment in shares, through share price appreciation and dividend income, rather than directly through property price increases and rental income. But while you get the benefit of the liquidity of an equity-like product, you also get the volatility of investing on the stock market.

Find out more: Investing in equities - find out more about investing in stocks and shares

Real estate investment trusts

The great majority (over 80%) of these property companies are known as Real Estate Investment Trusts (REITs), and have greater tax benefits than other listed property companies.

REIT companies don't pay corporation tax on their assets, on the condition that 90% of profits are paid to shareholders as dividends, which in turn could mean higher payouts. REIT investors pay either 20% or 40% tax, because they're classed as property-letting income.

Property investment trusts

Alternatively, you could invest in property investment trusts, which will pool your money to buy property and property company shares. The difference between these and REITs is that they're considered to be like any other company, so tax on dividends from the 2016/17 tax year is 7.5% for basic rate taxpayers on any dividends over £5,000. This increases to 32.5% and 38.1% for higher and additional rate taxpayers respectively.

Investment trusts can do things that unit trusts and OEICs can’t. For example, many property investment trusts use gearing - a process whereby the companies borrow money - to boost the amount they can put into property beyond what you have invested. While this can enhance gains in a rising market, it can magnify losses if returns fall.

Action point: Different types of investment - learn about the various investment products available to investors

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Last updated:

February 2016

Updated by:

Michael Trudeau


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