Why You Should Still Invest In Commercial Property

London's favoured, but there are discounts elsewhere, too.

Commercial property consists of buildings such as factories, offices, shops and warehouses, as well as land in general, which are rented out to tenants, and it is a distinct class of asset that possesses very different characteristics from shares and bonds.

If you want to buy an individual building, you'll need to put up a large minimum investment; running it will involve some administrative and legal work and it can be fairly expensive and time-consuming to find replacement tenants. Consequently, most people who invest in commercial property do so through a specialist property company or fund like the pan-European investment trust TR Property (LSE: TRY).

While commercial property companies haven't been the greatest of investments in the last few years, always remember that whenever you invest in anything you're doing so for the future and not for the past. Since many commercial property shares are currently trading at a big discount to their net asset values (NAV), you might spot a bargain if you look closely.

Property companies should be different

In theory, the share prices of property companies should move more in line with commercial property prices rather than with the rest of the stock market. Unfortunately this has not been the case in recent years.

During the financial crisis, some property companies such as SEGRO (LSE: SGRO) were caught out by their high levels of debt and also because many of their tenants got into financial difficulties, which caused them to default on their leases. As a result, the performance of many property companies' shares has been far worse than the market during the last five years.

The change in the law a couple of years ago that allowed property companies to convert to tax-efficient real estate investment trusts (REITs) did give a bit of a boost to the sector, but most companies' shares have since drifted back to lower levels.

The market likes London

While shares in the vast majority of property companies and REITs nowadays trade at a discount to their NAV, when it comes to those whose properties are almost exclusively located in central London you'll find that their shares trade at prices that are close to or even at a premium to their NAV.

The main reason for this is that the central London commercial property market really is different from that of the rest of the country. Not only do investors have more faith in central London property valuations, but London is also heavily favoured by foreign investors who are looking for a safe haven in a politically stable country which has strong property rights.

Show me the London money

I've summarised the key figures for the main central London specialists in the table below. Please note that in each case the NAV is the company's most recent headline figure.

Investors are quite happy to pay a big premium for Capital & Counties' shares because of the company's development potential, which includes projects like the 808 new residential properties in Earls Court for which it recently received planning permission.

Songbird Estates, whose main asset is its 69.3% stake in Canary Wharf Group (CWG), is the odd one out as it trades at a big discount to its NAV. There are several good reasons for this.

Why the bird is out of tune

Songbird's shares have been an awful performer since it was floated in June 2004 and it almost collapsed under the weight of its debts in 2009 before it was rescued by China and Qatar's sovereign wealth funds.

Songbird is one of the largest companies quoted on the Alternative Investment Market (AIM), with a market value of over £770 million, but many institutional investors ignore it because they aren't allowed to invest in AIM shares. Furthermore 76% of Songbird's shares are tightly owned by just four shareholders so they are very thinly traded and income-seeking investors aren't interested because they don't pay a dividend.

What Songbird does have, through its CWG stake, is a huge interest in one of London's fastest growing districts and an excellent development pipeline. Wood Wharf, which is next door to Canary Wharf, is now being redeveloped and CWG also has several joint ventures in progress including the new 'Walkie Talkie' building at 20 Fenchurch Street which it is constructing in partnership with the FTSE 100 (UKX) index constituent Land Securities (LSE: LAND).

I reckon that Songbird is a share for the very patient investor who is prepared to lock some money up for quite some time and won't get in the least bit flustered if the share price falls due to a general lack of interest. That's why I recently bought some with a five-year view.

Bigger discounts elsewhere

As soon as you move outside London, the discounts start to appear. Shares in Fool favourite McKay Securities (LSE: MCKS), a company that specialises in offices in South-East England, currently trade at 128p compared to an NAV of 229p. Another example is the Leeds-based Town Centre Securities (LSE: TCSC), which concentrates on retail outlets in the North of England and Scotland, whose shares you can pick up at roughly 55% of their NAV.

Commercial property is a sector that can pay great dividends for patient investors who are prepared to spend a bit of time looking through company reports and their development programmes. Furthermore, because the income produced by commercial property comes out of the tenants' pre-tax income, then as long as they remain marginally profitable they should still be able to pay the rent and thus your dividends.

Investing is by no means easy in today's uncertain economy. That's why we've published "Top Sectors Of 2012" -- our guide to three favourable industries. This free report will be dispatched immediately to your inbox.

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> Tony owns shares in Great Portland Estates, Shaftesbury and Songbird Estates.