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Property sector focus: Yield of themes

Samantha Downes reports that income remains the driving force behinds property investment

Property is back in vogue – among retail investors at least. In January this year, sales of property funds rose tenfold compared with the same month last year. Property funds took £1 in every £16 invested in funds during 2009, coming top in terms of sales in both October and November 2009.

This represents an almost total reversal of fortunes compared with 2008 when property was ranked 33rd most popular sector, with a net outflow of £466m. In 2009, it was the fourth most popular with total sales of £1.64bn.

This upward trend has continued, in January this year, property was the sector most favoured by investors, attracting funds of £373m.

Property funds have benefited both from record investor activity and an increasingly adventurous appetite among investors who are asking their advisers to look at alternatives to cash.

Central Wealth Management director Ian Smith believes investors want an income-producing asset to replace poor returns on cash.

He says: “It is about diversification, yields on property are good at the moment and voids are not that high. For our clients, property is more attractive than cash, which is making just 2 per cent at the moment. Property funds are seeing yields of around 6 per cent.”

Although optimistic, Smith believes property funds still only fulfil a niche part of a client’s portfolio. “We are not saying to clients go in and fill your boots. We are recommending a maximum exposure of no more than 5 per cent.”

Castle Court Consulting director Richard Gough believes investors looking for growth will need to hold on.

He says: “Values are not reflecting yields in certain parts of the UK, it is all about geographical area. But there is still an oversupply in some
areas, so you have to be extremely wary when choosing your fund.”

Gough is also using property as a cash alternative to shore up clients’ portfolios. He says: “Property is popular among our clients because they are looking at cash alternatives. I would say we are not out of the woods and property remains an element of a diversified portfolio. Withthat in mind, we are slowly drip-feeding small amounts of money into property but in a nervous sort of way.”

Gough says growth investors need not worry about missing out. “As primarily growth investors ourselves, I am saying to clients that it is not the time to rush in, things will still be same at the end of 2010 as they are at the beginning, the property boat has not yet sailed.”

Schroder Global Property Securities fund manager Jim Rehlaender says investors should not dismiss growth entirely. He says: “Property has an inflationary hedge appeal, real estate works well in an inflationary economy. Last year, of course, things were deflationary but we are expected to enter a more inflationary period and portfolios will need to be adjusted.”

Rehlaender believes future supply issues are already making property a very attractive option for bargainhunters and says: “Prices may be lower than they have been for two years or so but there are supply issues that willneed to be addressed.”

The recession has halted badly needed property developments and, by 2012, Rehlaender predicts that supply in areas such as London will be at an all-time low and that is when property funds will benefit.

He says: “In many major markets, rent levels have started to stabilise and even improve in certain cities such as London as lower-cost space is being absorbed by tenants more quickly than had been anticipated.” Swip property trust manager Gerry Ferguson says property is both an income and growth investment. He says: “Two things make property attractive, one was that its value had hit the bottom so it looked good value. Second, the interest rate is so low that people are looking for an asset that will them offer them higher rates than cash. In our fund, theaverage property yield is 7.5 per cent, a lot more than cash.

“At the moment, we are seeing investors who are seeking income but there are those looking for growth. It is very much dependent on where you are invested.

’Values are not reflecting yields in certain parts of the UK, it is all about geographical area. But there is still an over – supply in some areas, so you have to be extremely wary when choosing your fund’

The yield in some areas is favourable while others are fully priced, property in Mayfair, for example.”

Fidelity International special situations fund manager Sanjeev Shah says property stocks are offering compelling yields.

He continues to favour real estate stocks and is overweight in British Land and Land Securities. “The yield credentials of property continue to be overlooked by investors in what is a very low-yield environment. The average duration of Land Securities’ commercial tenants’ leases is around 13 years, usually with upward-only rent revisions.

“Assuming these tenants do not default and they shouldn’t as they are generally high quality, the rental yield exceeds the cost of financing and they have a locked-in income stream for a significant length of time.”

M&G managing director for global sales Jonathan Willcocks says that whatever growth can be extracted, income will always fuel the investment ethos behind property funds because of the rental yields it relies on.

He says there was a brief period when investors ploughed into property funds in anticipation of growth. This, he says, was what fuelled the property fund comeback last autumn.

He says: “People were taking profits from the corporate bond boom and putting them into property, this is what helped the upturn in property funds.”

“However, income remains the key driver of investment. In our funds, 70 per cent of total property returns come from income.”

With the property market still well off its peak of late 2007, Willcocks says fund managers will need to choose their portfolios more wisely than ever.

He says: “Rental income tends to follow GDP which is going to be anaemic this year. Things will not get much better during 2010.” This, he says makes factors such as good quality tenants and well placed property – industrial, office space or retail – all important considerations for investors, regardless of whether they consider their priority to be income or growth.

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