There has been a lot of hype around the high returns generated by buy-to-let, leading to speculation that many savers will use the new pension freedoms to release money from their retirement funds to invest in property to rent out. But investors often overlook the commercial property sector, which has produced stellar performance in recent years.
In 2014 commercial property made gains of 19pc, according to the Investment Property Databank. While experts aren’t expecting the same performance this year, many are tipping impressive total returns of between 10pc and 15pc.
This boom in commercial property is being driven by Britain’s growing economy. When the economy is doing well, there are more tenants seeking space for their shops, office and warehouses, so property owners feel more comfortable about charging them more rent. This then boosts capital values.
The reverse is also true, however, as many investors experienced during the 2007 financial crisis when commercial property slumped.
But with a newly elected Conservative government there is likely to be a renewed focus on growing the economy, which should benefit commercial property investors.
While it is very difficult to hold residential property in a pension, savers can quite easily invest in commercial property.
Top-rated funds
There are a number of funds that invest in the commercial property sector. Jason Hollands, of fund shop Bestinvest, says he usually prefers to invest in commercial property via investment trusts, a specialised type of fund that trades on the stock market.
The advantage of an investment trust is that the fund manager is not forced to sell assets if investors want their money back. Such sales are problematic when the assets concerned are difficult to sell quickly. It’s easy to sell shares, harder to sell an office block.
But property investment trusts are currently trading at big premiums to the value of their assets, meaning investors must pay a high price for access.
“With this in mind, I would recommend an ‘open-ended fund’ such as Henderson UK Property,” Mr Hollands says. Open-ended funds, such as unit trusts and the similar open-ended investment companies or Oeics, cannot trade at a premium.
“The Henderson fund is skewed towards London and the South East and holds quality premises such as the Coutts office on The Strand, the Travelodge at Kings Cross and Sainsbury’s stores. Rental yields are lower than on other funds because property prices in and around the capital have recovered strongly," Mr Hollands adds.
The fund is huge – worth £3.5bn – and currently yields 3.8pc.
Mr Hollands also recommends the F&C UK Property fund, which has a wider regional spread of properties. It is much smaller at £219m and yields 2.1pc.
“We also like F&C’s Commercial Property Trust, but it is an investment trust trading at a big premium so is a more expensive option,” he says.
Martin Tilley, of pensions advice firm Dentons, says the big benefit of property funds is that they give investors access to a spread of commercial properties, across different industrial sectors and different geographical regions. “This spread reduces the risk of tenant voids that exist with a single property. It also provides a balanced property portfolio that has been selected by a specialist manager who is expert in the sector,” he says.
The manager makes all decisions on behalf of investors, who have no direct control over the assets. But there are a number of costs investors must consider.
“You will have to pay for the investment and property manager, fund auditor and custodian, all of which can eat into returns,” Mr Tilley says.
Commercial property funds have higher running costs than funds that invest in other assets such as shares and bonds.
Because of the number of investors, these funds usually have a fair degree of liquidity, meaning that if you want to sell you can usually do so within a matter of days. But this is not always the case, warns Mr Tilley. “Property is a very illiquid asset and, when lots of investors are trying to exit at the same time, withdrawals may be restricted or even delayed for periods of up to six months.”
Buying land or commercial property
Telegraph Money has heard of many small businesses, and financial advisers in particular, that are buying their own commercial premises and putting them in a Sipp. As we explained on page 2, any small business owner can do this.
Those with a very large pension pot might also consider buying other commercial premises.
Claire Trott, of pension administration firm Talbot & Muir, says hands-off investors can use a property manager employed by the pension scheme to conduct all of the landlord duties. “This would eat into returns but would mean it is being dealt with by a professonal at all times and the saver doesn’t have to be hands-on with the property,” she says.
“But check first whether your pension provider will allow you to choose your own property manager, or whether it offers a full service that meets your needs.”
While the opportunity for considerable returns exists, there could be added costs if, for example, a tenant leaves and there is a void period.
Ms Trott says another option is to buy vacant land and get residential planning permission.
“By doing this the value is likely to increase and you can sell the land on before or during any building work,” she says. “It is usually best to have a buyer lined up before building begins because once the property is suitable to live in it will become taxable.”
Mr Tilley says direct commercial property investment is generally not suitable for inexperienced investors, and should always form part of a more diversified investment strategy within the pension fund.
