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Building bricks

Prospects for capital growth in the property sector may appear bleak this year but fund managers believe there is still room for income.
Property net retail sales almost halved last year to £508m, down from £1.8bn in 2010, according to figures from the Investment Management Association.

The IMA property sector saw £13m of outflows in December and £52m of outflows in August.

The Investment Property Databank says the average capital growth of 3,595 commercial properties across the UK in 68 property funds stood at 1.2 per cent in the 12 months to December 31. The average income return was 6.8 per cent.

Threadneedle Property Investments managing director Don Jordison says capital growth in the commercial property sector generally tracks the wider economy.

He says: “Many investors fear a double-dip recession as the Government’s austerity programme and the eurozone’s woes continue. It is unlikely that we will see any capital growth in 2012 but funds can still get returns from income.”

He says with many retail insolvencies, a proprietor of a retail business reaches an agreement with the landlord that sees the retailer’s worst-performing shops handed back to the landlord while those outlets that generate a reasonable profit continue to trade.

He says: “Investors are naturally concerned about tenant default, given the highly visible demise of well known retailers. However, retail insolvencies usually take the form of a pre-pack administration in which the whole company does not simply cease trading.”
Bestinvest senior investment adviser Adrian Lowcock says one of the key issues to consider for bricks and mortar funds that invest in direct property is liquidity.

He says: “We are in our risk-on phase but if that changes, and it can change quite quickly, you can see investors taking money out of property.

“In bricks and mortar funds, managers hold a lot of cash and that can drag on performance. It takes a long time to buy a property, so cash can build up. Investors should be looking for property investments that only have around 10 per cent cash in the fund.”

Lowcock says yields on open-ended funds are currently low, with some income returns of around 2 to 3 per cent but they are a good diversifier to equity.

He adds: “We currently favour property investment trusts, like Reits and close-ended investment trusts, which behave like equity investments but can get higher yields of 8 per cent or more.”

Kames Capital head of unit-linked property funds Sarah Cockburn says she holds around 10 per cent cash in the £968m Aegon UK property fund.

She says: “We hold around 10 per cent to protect against outflows and for capital expenditure requirements and we monitor it on a daily basis.”

The firm is planning to improving the liquidity of the fund through using derivatives and property shares.

Cockburn says: “The liquidity strategy of the fund is under review. We are looking to move into liquid synthetics and property shares in addition to our cash weighting this year. It is about protecting existing investors against a potential future market crisis. As we are a retail fund, people may take money out.”

Kames’ property team’s focus this year is on income, as capital growth prospects look bleak and only achievable through asset enhancement.

Cockburn says: “The key thing to asset management is enhancing returns above your income return by adding value through lease extensions, re-gearing leases for tenants, tenant engineering, which is taking one tenant out and putting another in, and selective property refurbishments and re-letting.”

Scottish Widows Investment Partnership head of wholesale real estate Gerry Ferguson says investing directly in properties gives more control of the assets than investing in property securities.

He says: “Rental income is stable in the sense that it is predictable, although there is a concern about a lack of growth in rental income. However, managers can just buy property where there are fixed rent uplifts in the rental structure and there are areas in the UK, like in London, that still have rental growth.

“Active management of property also works. We had a property in Brighton where we split the rent in two in November and overall the rent with two tenants was 20 per cent up that what we had before.”
Ferguson adds that the £2.3bn Swip property trust holds around 10 per cent in cash and has recently increased the use of derivatives to provide liquidity.

Exposure to derivatives has been increased from just under 1 per cent to 2.6 per cent over the past six months. Ferguson also expects to increase his 7.7 per cent real estate investment trust exposure to 9 per cent in 2013, as the market improves.

Ferguson says: “Although Reits do in the short term follow the stock-market and do have added volatility, over the long term they give a similar return to direct property. I expect an income return of 3.5 per cent to 4 per cent this year.”


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