There is no denying that income is the most prevalent theme in the current environment, with interest rates at rock-bottom levels and as a result of a population that is getting older. 
But because of those trends, and huge amounts of stimulus from the world’s central banks, the demand for income-producing assets never seems to have been higher with available yields on ‘safe haven’ government bonds still at very low levels.
Tourist’ fixed income investors have already moved en masse into the equity market, but given the higher level of risk that brings, many have also been seeking more defensive assets to hedge their portfolios against bond and stock market volatility.
One of the most popular destinations for those investors has been the open-ended commercial property sector, thanks to the dependable levels of income that ‘bricks and mortar’ funds can generate.
Performance of funds versus indices over 3yrs
Source: FE Analytics
As the graph above shows, investors have been well rewarded for buying direct property funds over recent years – especially relative to bonds and equities.
However, owing to that performance, the uncorrelated nature of those returns and the income they have delivered, many funds within the sector have been flooded with inflows meaning most managers are awash with cash (due to the illiquidity of the asset class) which could hinder future returns and dividends.
Therefore, for investors who are concerned about the future of open-ended UK commercial property funds, Cantor Fitzgerald’s Charles Tan highlights three investment trusts (which don’t have to deal with potential cash drags) for investors seeking alternative exposure to the property market.
All three of these trusts focus on more niche areas of the market, but Tan (pictured) says they are good options for investors who want a source of uncorrelated income and returns within their portfolios.
First up is the Tritax Big Box REIT, which yields 5.61 per cent and is trading on an 8 per cent premium. While that premium looks optically high, it is lower than the IT UK Direct property sector average, which sits on a premium of 8.2 per cent.
“Tritax Big Box is a FTSE 250 investment trust specialising in very large, highly efficient, purpose-built distribution/logistics assets – otherwise known as ‘Big Boxes’,” Tan said.
“It aims to deliver a net total return to shareholders of 9 per cent per annum or more over the medium term, comprised of a circa 6 per cent dividend yield and capital growth in excess of inflation.”
“In our view, the trust represents a differentiated way for investors to derive a steady, attractive income, underpinned by secular trends in technology and retail.”
Tan says the trust is particularly attractive as it offers investors exposure to a new theme within the UK.
“Due to widespread advancement and adoption of technology, consumer behaviour and very nature of retailing has changed.”
“In the last decade, shoppers have become increasingly savvy and demanding. Businesses have responded by centralising their logistics operations in order to keep costs down, and smart supply chain management now allows them to offer fuller product lines with less retail square footage.”
“It is this paradigm shift that is driving the rise of the Big Box industry, while diminishing the relative value proposition of high street retail space.”
According to FE Analytics, the Tritax Big Box REIT has returned 25.28 per cent since its launch in December 2013. While those gains are lower than the sector, it has comfortably outperformed corporate and government bonds and still offers a higher yield.
Performance of trust versus indices since launch
Source: FE Analytics
Given the quality of the management team and the REIT’s underlying portfolio, Tan expects that performance to continue.
“Due to the strategic nature of Big Box assets, tenants typically sign very long-term leases with landlords such as Tritax.”
“As a result, Tritax has a portfolio with an average unexpired lease of circa 15 years, and an attractive net initial yield of 5.8 per cent which, with the help of gearing, allows it to comfortably pay a 6 per cent dividend.”
Tritax Big Box has ongoing charges of 1.1 per cent.
Again this trust (which yields 5.5 per cent and sits on a 6 per cent premium) focuses on a less-mainstream area of the UK property market, but Tan says it would work well within a diversified portfolio.
“The strategy consists of a premium, direct-let offering and focuses on assets in the centre of the top 30-35 university cities, with the aim to generate total returns of circa 13 per cent per annum – split broadly between dividend income and capital growth,” Tan explained.
“In our view, Empiric’s business model is well-placed to benefit from the strong and steadily increasing demand for higher education, especially among the international student community, and should provide investors with a stable, uncorrelated and attractive source of dividends and capital growth over time.”
Tan says that student property is a booming area of the market at the moment, given that demand for higher education in the UK has grown over recent years. He points out that, while most of that demand has mainly been driven by international students, university applications are up over 40 per cent in just the past decade.
As the trust (which has gained 12 per cent since its launch in July last year) is biased towards “higher end” properties, Tan says Empiric Student Property is an attractive option to play this trend.
Performance of trust versus sector since launch
Source: FE Analytics
“As a result of its premium focus, the Empiric’s portfolio has a tenant mix which is naturally skewed toward more financially stable post-graduate students (almost 50 per cent), as well as international students.”
“Interestingly, because international students without a UK guarantor are required to pay the entire year’s rent upfront, Empiric has an enviable cash flow profile and limited risk of unpaid rents.”
The final trust on the list happens to be the most expensive on its current premium of 19 per cent to NAV. Nevertheless, given its current portfolio and status within the property market (it is listed on the FTSE 250 with a market cap of £1.1bn) Tan still thinks it is a good option for investors.
“LondonMetric Property [LMP] is an internally managed UK REIT specialising in retailer-led distribution, out of town and convenience retail, formed from the merger between London & Stamford Property and Metric Property Investments in 2013.”
“The current strategy focuses on acquiring and developing property that meets the ever-changing requirements of retailers, who LMP regard as their customers. LMP’s £1.4bn portfolio has evolved over the years, being repositioned to areas of growth, delivering strong shareholder returns in the process. In our view, this affirms the flexibility and value of the active management approach.”
“We believe LMP is well-positioned to deliver double-digit annualised total returns to investors over the long term, anchored by a progressive dividend.”
Tan also points out that the management team is highly experienced and with the portfolio’s bias outside of London, but focus on quality tenants (its largest tenants include Primark, Marks & Spencer, B&Q and Royal Mail), means it is a good option for income investors.
“LMP’s operating assets, with a circa 100 per cent occupancy rate and circa 13-year average lease length, provide the income base from which the dividend is paid.”
“With contracted rental income at £85m and growing, the dividend is now fully covered and has room to progress. Also, the access to pre-let developments and active management of LMP assets are what drive capital growth and are where the managers add most value.”
The trust, which doesn’t charge fees, has also increased its dividend from 6.3p per share to 9p per share over the past five years.
