Commercial Property Funds
What are They?
As the name suggests, commercial property funds are investment funds which invest in commercial property. Property has been neck and neck with equities as being the asset class with the greatest returns over the last decade. There is no direct correlation between performance of equities and commercial property, hence holding investments in both asset classes gives a level of investment diversification.
Why Commercial Property?
- There are usually greater returns to be gained with commercial properties, than with residential property.
- Commercial property is not as sensitive to interest rate rises as the residential property market.
- Commercial properties are typically purchased with strong corporate tenants in place.
- Favourable lease terms can include upward only rent reviews.
- Long term leases allow for the onwards selling of the property after the investment term, with valuable tenancies in place.
- Active management of the purchased property, such as through the redevelopment of the property, increases rental yield potential.
- Favourable loan terms can be achieved, due to the level of borrowings. These borrowings are at hands length i.e. in the funds name not the individual investors.
Although there are many property funds which do not use borrowings to fund property acquisitions, many investors seek commercial property funds which have a levels of borrowing (leveraged). Typically leveraged funds will use between 50% to 80% borrowings for the purchase of properties. At a level of 70% borrowings, the investor has increased the amount of capital invested by at least 100% (after purchase transaction costs).
During the investment term, the rent roll from the commercial properties purchased should be sufficient to repay the interest and perhaps some of the capital balance on the borrowings.
At the end of the term, the bank will be repaid the outstanding debt and the remaining proceeds will be distributed to the individual investors.
Leveraging the purchase, increases potential for greater gains when the asset in rising in value. Likewise, if the asset is falling in value, there is increased potential of loss of capital.
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