Rents in the retail sector are expected to come under pressure, leading Will Fulton, manager of the UK Commercial Property Trust (UKCPT), to reposition the company away from retail premises and towards industrials with greater growth prospects.
‘Our forecasts show there will be pressure on rents in the retail sector,’ he says. ‘They have done very well, particularly in central London, but continued growth looks unlikely given that businesses aren’t expanding as fast and economic growth is slowing for this market.’
Fulton started to reduce the company’s exposure to retail property shortly after he took over the trust two years ago. The subsequent result of the EU referendum has increased the likelihood of a slowdown in the sector.
UK retail property may suffer from reduced demand and uncertainty in the wider economy, while some international retailers using the UK as a bridgehead to Europe may be deterred – at least in the short term. Likewise, pan-European retailers may opt for France or Germany as a first port of call for their headquarters.
Fulton believes that industrial property offers greater rental growth potential. ‘Industrials are a really exciting market at the moment,’ he said. ‘There has been so little new supply built over the last ten years. At the same time, demand is growing due to structural changes in the retail marketplace and that is flowing through to real rental growth, which has benefited our performance.’
Growth in e-commerce, for example, has led to higher demand for warehouses and distribution units. Around 45% of the company’s exposure to industrials is in ‘big box’ logistics warehouses.
Buys and sells
Fulton has bought and sold property worth more than £400 million since he took over management of the investment company in April 2015. In his first year at the helm, he transacted £308 million of stock and in his second year £99 million.
The effect of this has been to decrease UKCPT’s weighting to the retail sector from 45% to 38% at the end of March, giving it a marginally underweight position relative to its benchmark, and increase its weighting to industrials from 26% to 33%, a 12% overweight compared to the benchmark.
Retail assets sold include an a block of properties on London’s Kensington High Street to an overseas family office due to concerns over how the extension of Westfield London shopping centre would impact future rental growth, and Weston Super Mare’s Sovereign Centre on the grounds that it needed significant capital investment without any additional return.
Sale proceeds have been reinvested in industrials that provide a sustainable income with rental growth potential. Purchases include Ventura Park, a 35 acre industrial estate located just off the M25 at Radlett, providing strong connectivity to both London and the wider UK. The estate produces rental income of £4.2 million per annum from 13 industrial units that are fully let to tenants with strong covenants including DHL, Kelly’s self-storage, B&Q, EE and Warner Brothers Studios, providing a net initial yield of 6%.
The company has also bought a pre-let prime warehouse development in Burton upon Trent with a yield on capital of 5.8%.
Depth of resource
UKCPT has £71 million left in cash available for investment. Fulton became a member of the Royal Institution of Chartered Surveyors in 1990 and three other surveyors dedicate 100% of their time to the company. They are always on the lookout for opportunities.
‘It’s very much a people business and with almost 30 years’ experience [in property investment], I know a lot of people and that helps,’ said Fulton. ‘We see almost all deals – both on and off the market.
‘Standard Life Investments has a far larger team of property professionals so we have a tremendous depth of resource to pick up opportunities.’
One area to which Fulton is keen to increase exposure is long leases with index-linked increases. The Burton upon Trent deal is a good example of this; the tenant has committed to a 15 year lease with annual inflation-linked rent increases of between 1% and 3%.
The company’s focus on quality enables it to attract the best tenants and boast one of the lowest void rates in the sector – 4.1% versus a sector average of 6.9%. This helps to support a robust annual dividend yield that currently stands at 4.1%.
Winterfloods is positive on the changes Fulton has made and believes they have made the company a ‘more attractive proposition’.
‘Recent performance is also encouraging and, while the dividend is not entirely covered, the fund has significant financial flexibility and we would anticipate it reaching full cover as available cash is deployed,’ it said in a broker’s note.
‘The fund’s largely prime portfolio and very conservative balance sheet leaves it well positioned to weather more difficult market conditions and its size means that its shares offer good liquidity in the secondary market.’
For further information, please visit our investment trust web site: www.standardlifeuksmallercompaniestrust.com
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