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The Value of Debt on Property Investment Market Performance

Author/s: David M Higgins

Date Published: 1/01/2014

Published in: Volume 20 - 2014 Issue 1 (pages 45 - 54)

Abstract

Commercial property is a physical asset class that forms an important part of the capital market universe. Due to illiquidity and high value thresholds, commercial property investment generally requires considerable equity and debt funding. Whilst debt funding can improve property investment returns, it substantially increases the level of risk. Over 28 years, on Australian data, the research showed the average indicative property floating and fixed lending rates were similar, in a range of 9.3% - 10.1% per annum. This compared to average desmoothed commercial property total returns of 10.2% per annum which included two periods of negative returns (March 1989 - September 1993 and September 2007 - September 2009). Overall, the application of high debt levels (80% leverage) can lead to a 30% improvement to annual commercial property total returns (13.3%), although the risk (volatility) is increased fivefold (11.4% to 57.3%) and can lead to a wide (280%) performance range. In demonstrating the impact of gearing levels on desmoothed total property return performance, recognition is required that the management of debt and the associated stability offuture property income is a central part of a property investment strategy.

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Keywords

Commercial Property - Investment Analysis - Property Leverage

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