Diversification benefits of European listed property

Here are some of the ways that European listed property can benefit your portfolio.

Diversity

Having the ability to invest across different geographies and sectors is a great diversifier. The correlation between individual stocks in any single country is high, which makes it difficult to add value if investing in a single sector, or in a single market. A pan-European strategy means that investors can enhance returns above those from a single country. Owning a number of securities can also spread income risk by providing exposure to a broad range of managers, countries, sectors and buildings; thus mitigating single tenant or building risk.

Dividends

Continental listed property companies can offer a superior income return to their UK counterparts and also to the wider European equity market (see chart 1). This is because continental REITs have much higher payout ratios than the UK. Listed real estate stocks in the UK only pay a dividend in line with UK equities, despite being invested in a high income part of the market. The UK market is more cyclical, with peaks and troughs, so UK companies will tend to hold back some income to develop and exploit the peaks in the cycle. Capital growth is, therefore, a greater component of total return for UK stocks than for continental property companies – valuations on the continent tend to be less cyclical and more stable.

Leases are also indexed on the continent, which means that each year rental incomes rise in line with inflation – inflation-proof earnings! Income from property is also secure because it comes from rent, which is protected by a lease. The legal nature of a lease means that tenants can’t just stop paying rent when times get tough. As a result, listed real estate is a good investment option if you like earnings stability.

Reduce volatility

Sometimes, property shares are perceived to be more risky than holding direct property. Indeed, over one month, listed property in the UK is more closely correlated to equities than direct property. This is mainly because short-term performance is often driven by investor sentiment and the effect it has on share prices. If we look at the medium term, though, the relationship changes and listed property becomes increasingly correlated to the direct property market. The same political and economic influences drive both parts of the property market, and over time, this means returns will – in the end – follow almost identical trends. Assuming a hold period of two years, the correlation between listed and unlisted is high at 0.8, based on analysis we have done on the UK market. As such, assuming these assets are held for a reasonable length of time, holding listed property is no more risky than holding direct property.

Increase flexibility

Investing in listed real estate can make funds more flexible and efficient from a trading point of view. Property shares are cost-effective and liquid investments, meaning they are easily and quickly traded. There are also no barriers to entry, such as the high capital and transaction costs that are associated with the direct property market.

Outlook

Investors are shunning anything eurozone-related at the moment, and fleeing to perceived safe havens such as bonds and cash instead. But listed property is actually a steady and safe part of the market, as the majority of total return comes from income. And it is all about income in the current environment. Property stocks are currently trading at discounts close to 20 per cent, so they are looking cheap. This is a good time to buy in order to take advantage of future share-price growth, and the income and diversification benefits that the asset class can offer.