Property funds have bounced back from a sharp sell-off following the EU referendum, and sentiment and returns in the sector have improved despite the lingering political uncertainty. Furthermore, the sector continues to provide an elevated yield compared to other assets.
Development continues to be relatively constrained by historic standards and existing vacancy rates are below long term average levels, which should all help to maintain the positive returns the sector is currently recording. In this environment, the steady secure income component generated by the asset class is likely to be the key driver of returns going forward.
Emphasising the recovery, almost all investment trusts in the Property – Direct UK sector are now trading at a premium, having recovered from double-digit discounts following the ‘leave’ vote last summer. The average premium stands at 5.2% – a far cry from the sector’s 12-month discount high of 17.2%, data from Winterflood Securities shows.
In terms of sector allocation, the Standard Life Investments Property Income Trust remains tilted towards the industrial sector, which continues to benefit from supply chain reconfiguration as more goods are bought online and the favourable fundamentals of elevated demand and limited supply within the sector. In line with the ‘house view’ that advocates taking profits in the Central London market where prices have more than doubled from 2009, the fund’s manager, Jason Baggaley recently exited City of London offices with the sale of the company’s then largest asset, White Bear Yard in Farringdon, for £19 million, having bought it in 2004 for £6.75 million.
‘White Bear Yard has been a wonderful investment for the company, but it was time to sell as it had increased downside risk given its location and lease profile,’ said Baggaley.
‘As a result of the sale, the company has no exposure to City of London offices and will be reinvesting into assets that offer a stronger income return with less volatile capital expectations.’
One of his recent purchases is a multi‐let industrial scheme in Bristol for £5.27 million. The eight unit property is fully let to seven tenants and provides the opportunity for asset management through lease re‐gears and renewals over the next three years.
Gavin Haynes, managing director of Whitechurch Securities, believes it to be a sensible strategy. ‘The yield on many areas of UK property is looking attractive at present versus low bond yields, but such rich valuations [as per the Cheesegrater deal] certainly provide some concerns and it seems a prudent move by Jason Baggaley of the Standard Life Investments Property Income Trust to have exited London offices,’ he said.
In an uncertain world, experienced property fund managers are focusing on the following factors:
Good quality tenants
As the source of income, tenants are reflective of the value of the property.
‘The better the tenant the more likely they will be around to pay rent each month and year,’ said Adrian Lowcock, an investment director at Architas, the multi-manager. ‘The other issue here is the vacancy rate: the lower the vacancy rate the better as it means more of your property is generating an income for longer.’
Long leases give greater certainty over current and future income. Another approach is to buy slightly shorter leases and re-gear these to grow the income stream.
‘I need to find an attractive pricing entry point and do that through buying slightly shorter leases than the market average,’ said Baggaley.
The trust is trading on one of the highest premiums in the sector at 10.1%, possibly because it has one of the highest dividend yields in the sector at 5.3%. The dividend is fully covered (117% covered in 2016).
Good quality property
Good quality property stands to better weather any storms.
‘In the event of recession secondary property is more likely to fall further in value as it has poorer quality tenants who may go bankrupt and costs more to maintain over the longer run as it needs investment,’ said Lowcock.
The most active managers in the sector have been taking profits where they see the chance to realise value and reinvesting the proceeds elsewhere.
Buying good quality property at a good price is critical. ‘If the price becomes expensive or the outlook for those properties changes then there is always a right price at which to sell an investment,’ added Lowcock.
‘The City of London had been seen as prime real estate as demand for property was growing, but with a number of large properties having been built in the area, the threat of Brexit to the city and technology making it easier for staff to work from home or elsewhere in the UK, it is easy for some to reach the view that the City of London has peaked.’
Managers of property investment trusts can also limit the amount of risk they are taking by taking a measured approach to their borrowing.
‘If investing in property trusts then the level of gearing needs to be considered in assessing the risk profile,’ said Haynes. ‘Whilst gearing enhances yield and the highly geared trusts have performed very strongly in a positive climate it is important that investors understand how gearing can amplify losses when the cycle turns.’
Tony Yousefian, investment trust research specialist at FundCalibre, points to the long-term prospects of managers who take a robust approach to risk management.
‘Longer term the relative stability of the income stream from property cannot be faulted,’ he said. ‘As an income generating asset class it remains a valid proposition especially with managers who have been positioning their portfolios defensively.’
For further information, please visit our investment trust web site: www.standardlifeuksmallercompaniestrust.com
The opinions expressed are those of © Standard Life Aberdeen as of July 2017 and are subject to change at any time due to changes in market or economic conditions.
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