Understanding the risks of commercial property investments
There are some very obvious differences between property investments and other kinds of investment. Firstly, property is a physical asset, unlike bonds or gilts or shares in a company. It cannot be sold at a moment’s notice through a central exchange, unlike other forms of investment.
Property offers one of the most stable prospects for a return on investment, but this is not without risk. There are costs and responsibilities associated with property that set it apart from other types of investment. Let’s take a look at the main types of risk involved in commercial property investments…
Property as an asset
The value of property assets can go down as well as up. Holding one particularly valuable asset poses a particular risk, as does holding assets all in one limited geographic location or of one type. For example, purchasing several assets in an area where the economy is dependent on one key industry will increase risk.
Your property value will also be dependent, in part, on the quality of tenant you can secure. Tenants with strong financial status, good business prospects and on long leases add the most to your property value. Short leases and more precarious tenants threaten your income. Value can also be affected by environmental factors, such as flooding, land contamination and nearby developments.
All shares of a particular stock are of equal value, but properties are much more difficult to value accurately. Valuations are usually made by independent assessors and subject to negotiations between parties; it is possible for values to vary or lag behind developments in the market. Sometimes this may work in your favour, but it adds an extra layer of uncertainty; you can’t know for sure what your asset is worth until you come to sell it. Your investment is also illiquid in property. It can take considerable time to sell property and access the funds locked up in it, even in a buoyant market.
If you’re using finance to purchase property, your ability to borrow and the cost of loans will be affected by market conditions. This includes interest rates as well as the willingness of banks to lend: following the financial crash, many would-be borrowers suddenly found themselves frozen out of the market as lending rules were tightened.
The caprice of the market is especially testing in the context of property development. This is a notoriously difficult area, offering excellent returns in healthy market conditions, but proving financially disastrous if the economy takes a turn for the worse.
It’s easy to forget that property prices and trends are not what will really determine the value of your asset: the unique qualities and characteristics of the building and its surrounding area are what push value up or down. In an area where the economy is going well, businesses are often looking for larger premises so they can expand. When a downturn takes place locally, companies often seek out smaller premises or enter insolvency, causing a sharp drop in demand for commercial property.
There is also the perennial issue of regulation. Whether it’s a directive from the EU or a UK law aimed at improving safety or environmental performance, environmental law can prove a major headache for property owners. In the long term, tenants may benefit from energy savings when properties become more efficient, but in the short term owners often find themselves having to invest in new systems or manage unexpected legal liabilities.
The hand of government can also touch property owners in the form of tax changes. The value of property and its attractiveness as an investment can be impacted by changes in tax rules, such as the recent increase in Stamp Duty Land Tax (SDLT) for purchasers of additional homes. Such changes can happen at relatively short notice, causing minor shocks for investors.
Interest rate changes and currency fluctuations are often unpredictable, and they can bring far-reaching changes within the property market. If you invest in property outside your home country, a currency change can have a dramatic impact on your investment. Meanwhile, interest rates affect government bonds and equities as well as repayment rates for loans.
Is property investment right for you?
The risks outlined above should be considered carefully before investing in property, and factored into your management strategy for your portfolio. This is not an exhaustive list and you should seek the advice of a professional to clarify the risks involved in any given investment before proceeding.
If you need insurance to protect your investment in commercial property, why not talk to Stride about the range of products on offer today?