Why invest in property?

The capital values of residential property are driven by supply and demand.

The supply of property is fixed in the short term, and is elastic in the long term, though it is highly regulated by planning laws.

Demand usually far outstrips supply, which results in the government targets to build new homes. But real demand is largely determined by the availability and cost of mortgage finance, and by the relative affordability of renting over buying for first-time buyers.

The level of returns from rental investments will be affected by this relative affordability factor, issues such as individual demand within particular areas, and other factors such as employment levels.

In very simple terms, the returns from commercial property are driven by the level of rental income that a property will return, and the price (i.e. the capital price) investors are willing to pay for that rental income.

The level of rental income that a property will return is determined by tenant demand for that property and the quality of covenant that the tenant can provide - that is, the certainty that the landlord will continue to receive the income for the duration of the lease. So the value of a tenancy held by a blue-chip tenant - say a government department or utility company - will be greater than that held by a less certain company - for example, a local fashion retailer.

In considering rental levels, the opportunity for increasing rents is also important. This can be achieved either through improving the property, or as a result of external changes in the market that affect demand for the property and therefore the rent it can command. For example, increasing economic activity might increase demand for the property in a location, which might push up rents or, conversely, the development of newer alternative property nearby might decrease that demand.

The factors affecting the performance of the core sectors within the commercial property market - offices, retail and industrial - are largely related to the relative supply and demand for specific sectors.

Although related, the supply and demand trends don't always move together. So, for example, demand for retail premises is primarily driven by consumer demand, while demand for offices is driven by employment levels.

Of course, given the length of time it takes to build a new shopping centre or a new business park, developers of commercial property are always trying to forecast future demand. It is often the mismatch between supply and demand in specific sectors (and specific locations) that produces changes in rental levels and capital values when premises are available to rent.
 
Supply in the UK is also particularly constrained by strict planning laws and a relatively limited (and fixed) supply of land.

Some factors that affect property performance are common across the globe. However, performance is also affected by local supply and demand (as determined by local economic conditions), and, of course, by the differences between the make up of different economies and their relative development and stage in the economic cycle.

Another factor affecting property performance across the globe is the ease with which overseas investors can access property investment opportunities in any particular territory. This will be affected by the local legal situation, including issues such as whether foreign companies or individuals are allowed to own property, which investment vehicles are able to operate, and how easy it is to repatriate profits to the home territory of the investor.

In essence, the level of access overseas investors have to a market on equal terms with local investors and the ease with which it's possible to assess and mitigate risk will determine how attractive a particular market is to global investors. The less attractive a local market is, the less global demand there will be - thus, performance will be reduced.

Indirect property investment performance, both local and global, is driven by two additional factors to those of direct property performance.

First, there's the factor of supply and demand for the investment vehicle. The performance of UK REITs, for example, was adversely affected during 2007 and 2008 by a drop in demand for shares because excess demand had pushed prices out in previous years (following the announcement that UK REITs would be launched).

The second factor is the impact of the investment vehicle on the underlying property assets. Almost all UK REITs, for example, are equities listed on the main market of the London Stock Exchange. Their performance in the short term closely follows that of financial stocks, with whom they are grouped and reported on.