The global economic recovery has enabled property funds to haul their way out of the financial crisis, says Nick Sudbury. But what are the prospects from here?
Bricks and Mortar
Standard Life Investments Property Income
The last five years have been a good time to be invested in UK property funds, with the sector generally rebounding strongly after the financial crisis. And one of the best performers over this period has been the Guernsey registered investment company, Standard Life Investments Property Income (SLI), with a return of just under 135%.
SLI provides exposure to a diversified portfolio of UK commercial properties, combining all the three main types of premises – office, retail (including leisure), and industrial. Its mandate also allows it to invest up to 10% in other types of commercial properties, as well as a similar amount in property development and a further 10% in related securities.
At the end of March the total market value of its portfolio was just under £189 million, of which 39.1% was financed by debt. (Total assets in late May were just over £200 million, including current assets.) The largest exposures are in industrial 25%, retail 19%, South East offices 19%, offices elsewhere in the UK 15%, plus 12% in Central London offices. Its key holdings include the Tesco distribution warehouse in Bolton, the offices at White Bear Yard in Clerkenwell and the Ocean Trade Centre in Aberdeen.
The fund aims to provide an attractive level of dividends with the prospect of capital and income growth. At 6.3% it has one of the highest yields in the sector with the distributions paid every quarter. This could improve even further if it converts to a UK based REIT, as is expected later in the year. After conversion it would have to distribute 90% of its rental income to shareholders and would not have to pay corporation tax on rental profits or capital gains.
In the last few years the improvements in the UK economy have resulted in higher property values and a stronger rental market. The fund manager, Jason Baggaley, expects this trend to continue and thinks that investors will make reasonable total returns on a 3-year holding period. The main downside is that the shares are currently trading on a 10% premium to NAV and the ongoing charges are relatively high at 3.42%. We should add, though, that this is mostly due to the nature of the underlying holdings as the AMC is just 0.75%.
Name: Standard Life Investments Property Income (SLI)
Type: Investment Company
Sector: Property – Direct UK
Market Cap: £118m
Launch Date: December 2003
Net Gearing: 149%
Ongoing Charges: 3.42%
Manager: Standard Life Investments
Companies, Not Buildings
Aberdeen Property Share
The cheapest way to gain exposure to the sector is to buy a fund that invests in a portfolio of listed property companies rather than in the actual bricks and mortar. One of the top performers in this area of the market has been Aberdeen Property Share, with a five year return of 119%. It is managed by the firm’s pan-European equity team, who aim to achieve both income and capital growth, with the distributions paid twice a year.
Property stocks – and the market in general – have benefited strongly from the government’s loose monetary policies, with the economic recovery leading to a significant pickup in demand from corporate tenants. The biggest driver of returns has been low interest rates, which have provided a massive boost by reducing the cost of debt while at the same time increasing investors’ appetites for high yielding assets.
Aberdeen Property Share mainly invests in the UK, although it currently has around 17% allocated to various countries in continental Europe. Its £299 million portfolio is divided between 26 different holdings, with the largest weightings in the range of 6% to 7%. These include the likes of Unibail-Rodamco, Land Securities Group, Derwent London, and Great Portland Estates.
The great benefit of investing in property securities rather than the actual buildings is that you can achieve much greater diversification – and that it is far easier to change the individual holdings. In fact, with a remit like this, the managers can target anything from industrial facilities in Europe to house builders in the UK, and even retailers like Tesco that own large property portfolios. It is also reasonably cheap, with ongoing charges of 1.61%.
The main downside with this sort of fund is that the underlying share prices tend to be a lot more volatile than the values of individual properties. This is especially the case given the fact that most of these companies have relatively high levels of debt, which leverages their exposure to the market. A significant economic setback or an increase in the likelihood of higher interest rates is likely to have an immediate detrimental impact on the value of the fund. Investors should also be aware of the relatively low yield, as most of the income is not distributed.
Name: Aberdeen Property Share
Sector: IMA Property
Fund size: £299m
Launch Date: October 1990
Ongoing Charges: 1.61%
Manager: Aberdeen Asset Management
Go West, Young Man
Morgan Stanley Investment Funds US Property Fund
If your clients are looking to diversify their property exposure internationally, they might be interested in the Morgan Stanley Investment Funds US Property Fund. It is structured as a Luxembourg SICAV, although the shares can be distributed in this country.
The fund aims to provide long-term growth by investing in a portfolio of publicly-traded American REITs and other similar property companies. All the underlying holdings are denominated in dollars, so the returns will be affected by variations in the sterling-dollar exchange rate. This is currently trading at a multi-year high, so if you are expecting a reversal this would be one way to benefit.
The last five years have brought a strong recovery in both the US economy and the housing market, and this has enabled the fund to generate an impressive return of 166% in dollar terms. At the end of March the $540 million portfolio was allocated between 44 holdings, with the top 10 accounting for almost 63% of the value. These include companies that focus on regional shopping malls like the Simon Property Group, and businesses that provide apartments such as Equity Residential. The fund also provides exposure to hotels, industrial properties, offices, self-storage facilities and specialist health care premises.
The managers take an active approach that is based on the firm’s value-orientated, bottom-up investment strategy. This uses internal proprietary research to identify those property companies that offer the best value relative to their underlying assets and growth prospects. It is a detailed process that takes into account factors such as values per square foot, yields, lease expiration and the quality of the management team.
As mentioned, the fund has made an impressive annualised return of 27% during the last half decade. But, perhaps more realistically, the equivalent figure for the whole decade was an equally creditable 7.39%.
It remains to be seen whether the US recovery will run out of steam once the asset purchasing programme is wound down, and how much of a headwind there will be when interest rates start to pick up to more normal levels. But there is genuine reason for optimism here.
Name: Morgan Stanley Investment Funds US Property Fund
Type: Luxembourg SICAV
Sector: Property – Indirect North America
Fund size: USD 540m
Launch Date: January 1996
Manager: Morgan Stanley Investment Funds
Taking a Chance on Europe
Tamar European Industrial
If your clients expect the economic recovery in Europe to gather pace, they may be interested in the Tamar European Industrial fund (TEIF). This closed-ended, Guernsey registered investment company is tiny, with a market value of just £49 million, but it is one of the few high yielding funds to be trading at a near 40% discount to NAV.
TEIF aims to provide an attractive level of income and the potential for capital growth by investing in a portfolio of industrial premises in Western Europe. Over the last five years the shares have risen 113% – yet throughout that period they have consistently traded well below their NAV, with the discount occasionally touching 50%.
Most of the company’s portfolio of 39 properties is located in France, Benelux and Germany. At the end of 2013 these had a combined market value of £139.1 million. The total debt stood at £75.3 million, giving a gearing ratio of 54.1%, which is often expressed as 154.1%. This sort of high leverage will multiply the impact of positive or negative asset returns on the fund’s NAV.
In the latest accounts the Chairman says that there have been gradual signs of improvement in their markets with the momentum building towards the end of 2013. This has enabled the management to dispose of most of its Nordic properties at a premium to book value, and to extend the debt facility to July 2015.
At the end of December, 62% of the portfolio was located in France with a further 16% in Belgium and another 12% in Germany. The average length of lease remaining or until the next break clause was 2.9 years, and the overall running yield was 7.24%, which is well above the historic dividend yield of 4.29%. Another positive piece of news is that the AMC has recently been reduced and from 1st July will be 1.35% per annum of the mid-price NAV.
The European industrial property market has had a rough time of it, but there are signs that it has finally turned the corner. This is reflected in the gradual opening up of the debt markets and the improvement in investment volumes. If this continues it seems unlikely that the shares will remain at such a wide discount, although the significant level of debt means that the fund would only be suitable for clients looking for a high risk exposure.
Name: Tamar European Industrial (TEIF)
Type: Investment Company
Sector: Property – Direct Europe
Market Cap: £49m
Launch Date: September 2006
Net Gearing: 177%
New AMC: 1.35%
Manager: Patrizia Capital Partners Limited