Investors seeking exposure to UK property could consider the likes of the Custodian REIT, Picton Property Income and Schroders UK REIT investment trusts, according to the analysts at Numis Securities.
Property funds jumped into the headlines for all the wrong reasons last year after the sector was hit by an unexpected increase in stamp duty in the Budget in March and the UK’s vote to quit the European Union, which led to several open-ended funds suspending trading.
The IPD UK All Property index posted a total return of just 1.41 per cent for 2016, which is a far cry from the gains of recent years: the index rose 13.89 per cent in 2015, 19.46 per cent in 2014 and 11.02 per cent in 2013. The average property investment trust made 5.23 per cent last year, however.
Performance of sector vs index over 5yrs
Source: FE Analytics
A report by Numis analysts said: “The three years preceding 2016 were characterised by significant capital flows into the sector, driving property values higher (investment yields lower), generating double-digit returns for investors. Whist the market had expected a slowdown in 2016, with income taking over as the key driver of performance, few expected the slowdown to be as rapid.”
“It was a volatile year for the UK property investment companies, which suffered a sharp derating following the Brexit vote and restrictions on redemptions imposed by numerous open-ended property funds. Some property investment companies reached discounts of 30 per cent, but these tightened rapidly once investors appreciated that there would be no forced portfolio sales. Overall, investors in property investment companies made modest gains in 2016, primarily through income.”
While 2017 has the potential for more share price volatility in property trusts – especially because of the many potential political headwinds on the horizon – Numis suggests that some opportunities can be seen in the asset class.
Numis’ analysts say they prefer property trusts with modest gearing, defensive property strategies and well-covered high or rising dividend yields. One that ticks the boxes in this regard is the £349.6m Custodian REIT, which is managed by Mattioli Woods subsidiary Custodian Capital.
Arguing that Custodian REIT “should remain a solid performer”, the analysts suggest any share price weakness could be seen as an opportunity to add to holdings in the trust. It is currently trading on a premium to net asset value (NAV) of more than 8 per cent.
The trust, which launched in March 2014, focuses on good quality smaller properties that are valued at less than £10m; this part of the market has seen less competition and yield compression than larger lots, leaving properties on more attractive valuations.
Total return of trust vs sector since launch
Source: FE Analytics
“Management is keen to express that smaller lots do not mean lower quality buildings or tenants, but provide a good way to diversify income risk,” Numis said.
“Fundamentally, we believe that the management team has positioned the portfolio well for a slower growth environment by targeting investments with a high residual value i.e. the majority of value is in the bricks and mortar not the lease.”
Investors seeking more of a value approach could look at Schroder Real Estate, according to Numis, as the trust is currently trading on a discount to NAV of 7.7 per cent – the widest in the IT Property Direct UK sector.
“The portfolio has an attractive combination of core assets underpinning the current dividend target. The top ten tenants have an average lease length of 7.4 years, and generate circa 34 per cent of rent. This is augmented by some well-flagged asset management opportunities,” the analysts said.
“In particular, the manager has been strategically positioning the portfolio towards high growth, winning centres where the local economy is growing at a faster rate to the UK as a whole. Indeed, 54 per cent of the portfolio by value is located in the fastest growing centres, with a further 37 per cent categorised in second and third quartile.”
While they concede that the market is not currently putting value on the future growth potential of property, the analysts argue that patient investors could benefit from attractive total returns over the longer term, especially as the trust continues to pay a well-covered dividend.
A final property trust that Numis is backing is Picton Property Income, which is also trading on a discount. However, this is tighter than Schroder Real Estate’s at 3.4 per cent.
Total return of trusts vs sector over 5yrs
Source: FE Analytics
The analysts expect to see further positive momentum at some point in the coming weeks, when Picton Property Income reports its NAV for the fourth quarter of 2016. In particular, they expect that the portfolio will benefit from lettings that have been made in two of its largest industrial voids, which have been made ahead of their estimated rental value.
“We also note that Picton has committed but undrawn facilities available for future investment of circa £53m, giving it scope to take advantage of any opportunities that may arise,” they added.
In a coming article, we will take a closer look at the listed infrastructure trusts being highlighted by Numis.