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You are here: Commercial Property

Commercial Property


Commercial & Residential

Commercial chalk and residential cheese
Residential property is a different type of asset.

The focus of this guide so far has been on commercial property. Residential property, with which you will almost certainly be more familiar, is a different type of asset. The differences include:

Size of market
According to the 2004 UK National Accounts 'Blue Book', at the end of 2003 the total value of UK commercial and industrial property was £573.2 billion [o]. At the same date the residential property market was worth £3,044.8 billion [o], more than twice the value of the UK stockmarket [o]. The size of the residential market explains why governments and the Bank of England are so sensitive to its well-being.

Source: [o] National Statistics Data.
Lot size
The commercial property sector may be much smaller than its residential counterpart, but the average cost per property ('lot size') is much greater. For example, the average residential property price in the final quarter of 2004 according to Nationwide was £152,623, whereas the average value of commercial properties in the IPD's databank at the end of 2004 was approximately £10.99 million [p].

While both of these averages hide wide ranges, the two numbers serve to explain why institutional money is directed at commercial property and private investors mostly either choose buy-to-let residential property or indirect investment in commercial property, such as through unit trusts.

Source: [p] Nationwide and Investment Property Databank.

About 9% of the commercial and industrial sector (at end 2003) is in the hands of households with the vast majority split between non-financial corporations, financial corporations and the government. Owner occupiers however, are by far the largest sector of the residential property market, accounting for about 70% of housing stock [q]. Another 20% is in the hands of local councils and social housing bodies such as housing associations [q]. The investment sector, comprised of private landlords, represents just 10% of the market [q]. In spite of the boom in buy-to-let, the proportion has remained at about 10% for the last 20 years [q].

The dominance of owner occupiers means that they are the price setters in the residential property market. This is not the case in the commercial property market. The relatively small share of the private rented sector of the overall residential market can expose buy-to-let investors to the problems of over-supply, something that in recent years has driven down rents in London and the south east [r].

Sources: [q] Office of the Deputy Prime Minister, [r] RICS survey.
The average gross rental yield for residential property was 6.0% [s] at end 2003, similar at first sight to that of commercial property. The gross figure, however, overstates the income that the typical residential landlord receives after meeting their expenses, including management fees and maintenance and insurance costs. The latter tend to be higher for residential landlords because leases on commercial property usually pass full responsibility for maintenance and insurance on to the tenant.

According to the IPD, if allowance is also made for void periods – the empty periods between lettings – the actual net yield from residential property is more like 3.8% [s].

Net income from residential property is therefore typically lower than the net income from commercial property. It is also likely to be less secure because rental agreements will typically be for only six months or a year, much shorter than typical commercial property leases. Residential landlords often avoid long rental agreement terms because they tend to depress property values, whereas commercial property owners welcome long leases because they enhance their property values. Commercial property contracts also typically involve stronger covenants.

Source: [s] Investment Property Databank.
One of the major drawbacks for buy-to-let private investors is that most will already have substantial exposure to the residential property market through their own homes. Buy-to-let therefore increases their exposure to a single investment category. To make matters worse, a downturn in the housing sector is often associated with a period of high interest rates, as in the early 1990s. Buy-to-let investors may therefore find that the outgoings on their mortgages are at their highest when residential property prices are at their weakest – not good news if they are forced to sell.
State of the market
In the past couple of years, most pundits who have predicted the performance of the residential property market have been proven wrong. In particular those who since the start of 2003 have been forecasting that house prices were going to collapse have been forced to reconsider. In 2004 the average UK house price rose by over 12.7% according to Nationwide.

Rental yields have consequently fallen as prices have risen. With mortgage rates now also starting to rise, the potential for capital appreciation has become all the more important for buy-to-let investors. Although it might be difficult to call the top of the residential property market, there has been huge out-performance of residential property values since 1995 [t]. In contrast, commercial property values now are little different from their 1989 levels.

Source: [t] Investment Property Databank/Nationwide House Price Index (Bloomberg)/FTSE All-Share (Bloomberg).
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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.

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