It is no longer just the larger institutions dominating the commercial property investment sector. There has been a significant increase in private investors making long-term investments in commercial property. Here, we explain some of the reasons for this and offer a few tips on those considering it as an option
Property investment has taken centrestage for family businesses and wealthy individuals as a safe haven for cash as well as an opportunity to seal complex deals that are protected from some of the ravages of the financial markets.
The market is being driven by several factors. First, a significant number of people made their fortune during the 'new economy'boom of the late 1990s, particularly in the technology media and telecommunications (TMT) sector, where many start-up companies were bought out by bigger competitors.
The number of people with net assets greater than UK£1m living in the UK grew from 2% to 9% of the population between 1982 and 1996, and the growth of private banks, specialist advisors and others serving 'high net worth'individuals has continued into the Millennium.
In latter years, that growth has been fuelled by 'new economy wealth', despite the slump led by Internet companies and the TMT sector as a whole since late 2000.
Also, many family businesses have turned to property either as an addition to their core business or created property investment vehicles from the shell of their original activity.
For example, one long-established family business in Scotland and northern England closed its grocery stores one-byone as they were squeezed out of their sector by the supermarket chains.
The company had been founded in the early 1950s, and was well-established – with stores on many provincial high streets – until the early 1980s, when it began to flounder. The second generation of family ownership were well-established and held charge of the business. They knew they had to diversify or face what one director described as "death by a thousand cuts".
The director, who preferred anonymity, explained: "Rather than close down we started to sell a few of the larger stores as going concerns, but we wanted to maintain income for the various active shareholders as well as building a new business which might have future value. "
As a result, the business now acts as a property manager and investor, running more than 60 properties, many of them having once been part of the family grocery business. It retained high-profile tax advisors and invested in property management expertise, but its operating costs are much lower than in the previously barely-profitable food business.
There are other entrepreneurs who have made their money in one sector and then adopted property deals as one arm of a new investment-led business. One of the highest-profile in the UK is Tom Hunter, who made a personal fortune of £290m when he sold his sportswear chain Sports Division to its biggest rival, JJB Sports, in 1999.
Many people would have been forgiven for choosing a very early retirement with that fortune. But Hunter (now reported to be worth £400m) has launched West Coast Capital, an investment vehicle covering property, retail, leisure and technology. West Coast is now involved in various joint ventures, such as Fusion, which bought a UK portfolio including Kensington Arcade in London and the massive former Babcock engineering works site near Glasgow: a deal done with HBOS Bank and Montagu Evans.
Many private investors are becoming involved in syndicated property deals as a means of making long-term investments while spreading the risks and creating a liquid market for their shares. "A £1m investment offers little yield, but if you come together with 30 others to make a £30m deal you can work out a lot more, " explained property lawyer David Bankier, of McGrigor Donald.
"There has been a significant growth of private investments generally, where high net worth individuals are coming in with equity and typically some bank debt. They are soaking up available properties in some local markets. "
Some analysts are predicting that the days are over when big institutions – the insurers and pension funds – dominated the commercial property investment sector. Those giants, who owned major shopping centres and office premises in every town and city, are giving way to less conventional groups of private investors or joint ventures between funds and individuals.
They are using specially-constructed investment vehicles that deliver tax efficiency, portfolio management and even liquidity to a variety of ventures involving both institutions and private investment.
Advisors and others are much better prepared today to create deals for investors who want to see long-term gain often as a balancing agent against their shorter-term and more speculative investments, especially in the battered technology sector.
Approaching the investment
But pitfalls remain. And many potential investors remain wary of becoming involved in a sector unfamiliar to them. So how should an individual or business approach the investment?
In the US, the market has operated on a sophisticated level for some years. Specialist 'family offices'emerged there during the last 20 years, and many similar services are developing across Europe. In addition, consultancies such as Andersen have begun niche services for individual clients and businesses.
There is also significant support and information services such as the Londonbased Investment Property Forum (IPF), created in 1988 as an idea and information exchange for investment surveyors. The IPF runs a series of seminars, publications and research projects covering the sector. Its 1, 400 members include surveyors, fund managers, academics, bankers, lawyers, actuaries and other professionals.
A recent IPF survey estimated the UK private property vehicle (PPV) market to have a market capitalisation of £23 billion, out-stripping all similar investment during the previous 15 years.
Since 1997, there has been significant growth in limited partnerships (LPs) as the preferred vehicle for private investment. More than £5 billion was invested in LPs between 1997-99. And LPs are not the only vehicles for private investment of this kind: others include managed funds, specialist trusts and property unit trusts.
The proliferation of private banks – especially in the traditional areas of the UK, Germany and Switzerland – reflects growing demand for specialised banking and investment services for a growing band of wealthy individuals.
Strategic Real Estate Advisors (Stratreal) have emerged as a well-placed advisor serving this niche in the property sector. It believes that, despite the general current downturn, property investment in Europe remains strong. This is partly because major companies like British Telecom and France Telecom, or major institutions like Banca di Roma and the Swedish post office, have offered massive chunks of their own property portfolios onto the investment market.
Stratreal remain bullish about the American sector, although the Asia Pacific market is more difficult to predict. The specialists support the argument that real estate is a complex area, where investment requires strong specialist advice. But it remains attractive for a variety of tax and investment reasons.
Families in Business and Stratreal offer the following tips for those considering property investment:
Issue 1: What type of property?
The main distinction concerns: offices, retail, industrial, distribution, leisure and hotels, and residential. Other relevant attributes are size, age and condition. Rental income varies with each characteristic and so do the yields associated with both building type and condition.
Issue 2: Where is the property located?
Here the investor has to choose from a whole cascade of locations ranging from the three global regions of Europe, North America and Asia, homing down to national territories, provinces within the nation state and individual cities down to street blocks within a city. Again rentals and yields tend to vary widely between these categories. Property investment is a global sector, but incomes, tax regimes and structures vary at local level.
Issue 3: Who are the tenants?
Is the building occupied by a single tenant (an advantage from a management point of view) or by a multitude of tenants? What type of business do these tenants represent: bluechip companies, government offices or small local firms? When are the leases due for renewal and how much of the term is still to run? The investor should be warned about the variety of lease structures, and landlord and tenant legislation in different locations.
Issue 4: What are the market conditions?
This question needs to be addressed not only to the appropriate sub-market – for example, suburban retail – but also to economic conditions at the local and national level. There is a further distinction between the rental market and the investors'market; they do not necessarily play in unison. Investors and advisors should examine the yields in each of these markets.
Issue 5: What are the tax constraints?
Two types of tax are of concern to the investor: taxes applying to the user (eg land tax, local rates, income tax on rental income, VAT etc) and the taxes applying to the investor (eg capital gains tax, stamp duty, withholding tax on income transfers, VAT etc); both are likely to affect the return from a property.
Issue 6: How to finance the investment?
The obvious options are financing out of your own means, via a mortgage or a loan (ie geared) finance. If loan finance is envisaged a number of questions arise, such as whether it is to be financed by local credit institutions or from abroad? What is the cost of the loan? What are the terms of repayment? What are the requirements for due diligence and so on?
Issue 7: What is the appropriate investment strategy?
An investment strategy addresses the question of how to manage the property for the client so as to maximise the value added over the life of the property. This includes marketing to potential tenants, devising appropriate lease contracts, deciding on when and how to refurbish, and when to dispose of the property.