COMMERCIAL PROPERTY INVESTMENT

Do you want to know how to invest in commercial property at a 40% discount to underlying asset value, a 10% plus net yield, with a gearing of up to 90%, paying only 8.25% on the loan. Impossible right. Wrong!

This is how I’m doing exactly this now.

Many landlords and property investors are aware that commercial property shares have been going through a tough time recently with many of them having lost over 50% or more of their value over the last year.

The reason for this are three fold.

1. The credit crunch has made buying commercial investment property just as it has residential investment property more expensive and difficult to get
2. Discounts between the value of the shares in these companies and the value of their property portfolios have widened considerably from a point that their was no discount to the situation now where this discount is often 30-40% to that of the value of the underlying property portfolio.
3. The market expects further falls.

The result of all this is that net yields are now in excess of 10%, this present an interesting opportunity for adventurous property investors to be able to arbitrage between the cost of borrowing and the income generated from the shares dividends.

Where do professional landlords go for buy-to-let insurance?

One aspect that an investor needs to be wary of is that the dividend paid by the property company is sustainable. This is relatively easy to do by going to the companies most recent final or interim results on a share site such as Digitallook .

How do I leverage my share purchase?

This is the clever bit and the bit that many investors don’t know about. There is a financial product which is now quite common place called a Contract For a Difference or CFD. These enable an investor to purchase a share on a margin, effectively borrowing money to purchase a proportion of their holding. So for instance for simplicity sake if you wanted to buy 1000 shares in a company trading at 100p per share. Buying these on an 80% margin you would buy 20% of the thousand shares using your own cash and then the remaining 80% or 800 shares would be purchased using a loan provided by a company like Cityindex www.cityindex.co.uk on which you pay 2.25% above LIBOR which currently works out at about 8.25%.

Finance costs on a CFD would work out expensive, but if you hold a high yielding share such as one of the property stock I referred to, the loan costs on the 80% of the cost of your holding is easily paid for out of the dividend payments. An example of the figures might work out are as follows:

EXAMPLE ON 1000 SHARES

COST OF SHARE 100p
ANNUAL DIVIDEND 10p
YIELD 10%

MARGIN say 20%
LOAN THEREFORE 80%
OWN CAPITAL EMPLOYED 200 SHARES = £200
SHARES BOUGHT USING BORROWED MONEY 800 SHARES = £800

LOAN COST @8.25% ON 800 SHARES = -£66
DIVIDEND INCOME ON 1000 SHARES = £100

NET REVENUE = £34
ANNUAL REVENUE RETURN ON CAPITAL EMPLOYED i.e. £200 = 17%

The upshot is that even if share prices stay the same a landlord stands to benefit from a steady income. If shares go up because the discount to the value of shares to the underlying property assets starts to fall then the landlord could make considerable gains. Obviously the big risk for a landlord and investor is that the share price continues to fall but providing the investor is prepared to take a long term view they can keep the CFD going knowing that unless dividends are cut that the loan costs are covered and that eventually the property and share values will go up.

Actual example of potential share investments

One example of a commercial property share I hold and that I’m going to do a CFD in because after recent falls they now meet my criteria is:

ING UK Real Estate Income Trust Ltd

This is no fly by night property investment company. It is managed by ING Real Estate Investment Management (UK) Limited and was listed on the London Stock Exchange on 25th October 2005. The company’s aim is to provide shareholders with an attractive level of income together with the potential for capital growth.

Information in its Q1 2008 Newsletter showed that it had a property portfolio of £596.8 million and net assets of 102 pence per share. It’s share are currently trading at just less than 60p a share putting it on a discount to assets of over 40%. Its annual dividend is 6.25p which is over 10% net yield.

RISKS

There are of course risks in investing in shares and particularly in commercial property where values are still falling. These risks are that the company cuts its dividend to conserve cash or that they breach the lending covenant granted by their banks which normally stipulates that the loan to value does not rise above a certain level, typically 65-70%. However, landlords should also realise that in my view commercial property values are relatively cheap – how many residential investment properties yield a net yield above 10%. Also the falls in commercial property values are factored immediately into the share price, which also reflects expectations of future falls. If the market were to be able to do that with the average house price – I wonder what the current share market would value the price of our residential property investments at?

THE INCOME MONKEY

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