Property-focused
investment companies

Regaining favour with investors as demand for income continues

The property market has experienced some significant highs and lows since 2008 but is now steadily regaining favour among investors as property-focused investment companies are proving a source of much sought-after income. The Association of Investment Companies (AIC) has surveyed property managers for their views on the outlook for the sector.

Positive returns

The increasing attraction of property for investors can be seen in the discount movement from 32 per cent at the end of September 2008 to 6.5 per cent at the end of September 2011 for the Property - Direct UK sector. Income is a strong pull for this sector, according to the Investment Property Databank (IPD), with yields averaging 7.3 per cent, but returns have been positive too, up 23 per cent over the last three years to the end of September 2011 compared to the average investment company increase of 18 per cent.

Jason Baggaley, Manager, Standard Life Investments Property Income, commented: ‘Despite heightened volatility and unprecedented uncertainty resulting from the ongoing Eurozone problems, UK Commercial Real Estate continues to be one of the few asset classes to provide reasonable positive returns over the year to date.’

Attributable to income

Richard Kirby, Manager, F&C Commercial Property Trust, noted: ‘The property market has proved remarkably resilient in the face of slow domestic economic growth, fiscal austerity, a stalling of economic recovery overseas and the Eurozone crisis. There have been two years of sustained growth following a severe downturn. The initial sharp bounce-back has been replaced by a year when performance has been largely driven by income. In September 2011, the annual total return was 8.7 per cent, of which 6.9 per cent was attributable to income, according to the IPD Monthly Index.’

A more affluent population

In the UK property market, London continues to outperform other regions although this difference could become less marked. Richard Kirby maintained: ‘London has out-performed the regions, helped by a stronger local economy, a more affluent population, tight new supply, its role as an international as well as a national centre and its relative resilience to public sector cutbacks.

‘Overseas investors have been attracted to this market, with London seen as a large, mature, transparent and liquid market. This out-performance is expected to persist for the next year or so but the gap between London and the regions may narrow, particularly for City offices, given the turmoil in the financial and debt markets. Nor should prime property in regional markets be written off.’

Outlook for property

Although the long-term outlook for property is positive, investors must be prepared to weather any storms that may result from recent volatility. Jason Baggaley cautioned: ‘Some weakness in pricing is anticipated over the next few months as more stock is brought to market and it is likely that the softer prices are accentuated for secondary assets in poorer locations with greater investor demand continuing for relatively low-risk assets. Despite some softening in the prices for poorer- quality stock, reasonable positive total returns are expected over the next few years for investors as yields compensate for any modest capital declines.’

A reliable source of income

Higher personal taxation and reduced pension contributions, as well as an all-time low interest rate, have contributed to the growing importance of income to private investors. Managers recognise the need to protect income streams and emphasise the importance of careful asset allocation in a poor macro-economic environment.

Jason Baggaley said: ‘In the current environment, with a relatively weak economic backdrop, ensuring the quality and sustainability of income is a key investment decision-making criterion. Investors remain risk averse because of the economic volatility and are shunning poorer-quality secondary and tertiary stock at present.

Stock-picking opportunities

‘However, these conditions may provide ideal stock-picking opportunities for savvy investors where good value assets can be identified in relatively resilient areas and can be repositioned further up the quality spectrum. We expect asset management initiatives and locational choices to be the defining characteristics contributing to income returns into this year.

‘Currently, for multi-asset investors, real estate assets that are located in relatively robust locations with reasonably financially secure firms as tenants are likely to continue to produce a compelling positive sustainable income yield that compares favourably with the depressed yield on a range of other “defensive” type assets.’

Economic backdrop

Richard Kirby commented: ‘This year is expected to be more difficult given the economic backdrop and the downside risk implicit in the Eurozone crisis. There are positive elements. Low interest and borrowing rates coupled with a second round of quantitative easing may offer support. The UK may be seen as a safe haven from the troubles of the Eurozone.

‘Looking to the longer term, years of low development have led to areas of tight supply where a turnaround could be quick once demand recovers. For now, though, the focus needs to be on the protection of the income stream and securing its longevity. There are differences within the market and this will involve selecting and managing property at the asset specific level.’

A well-diversified portfolio

Property is regaining its place as a mainstay of a well-diversified portfolio. The closed-ended structure of investment companies is particularly suitable for this type of illiquid asset and the majority of the sector has bounced back following the property bubble of 2008/9. Property is once more in demand for its ability to provide investors with attractive levels of income.

All performance figures are mid-market share price with net income reinvested and a 3.5 per cent deduction for charges, stamp duty and market spread to end September 2011. Source: AIC using Morningstar. The value of these investments and the income from them can go down as well as up and you may not get back your original investment. Past performance is not an indication of future performance. Tax benefits may vary as a result of statutory change and their value will depend on individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.