Sector Focus: Solid yields hold key to commercial property


Consensus on the commercial property sector’s prospects is improving gradually, with most groups predicting annualised returns of 7 to 8 per cent in the coming years. Despite this, some investors understandably remain cautious on the asset class, with many funds forced to shut down temporarily at the height of the credit crisis as money flooded out.

For those willing to take another look, the property fund sector is not the most helpful place to start, with portfolios investing in companies involved in the industry, real estate investment trusts and actual bricks and mortar all lumped together in a single peer group. 

As expected, property share vehicles are by far the stronger performers over the past few years, dragging up the sector average and making it look – on the surface – as if direct portfolios are underperforming.

Aberdeen Property Share is comfortably the strongest fund over 12 months and three years to mid July despite a muted macro backdrop. Run by the group’s pan-European equity team – headed by Jeremy Whitley – the portfolio has maintained its focus on property companies able to create value amid such conditions.

“Expectations for further yield compression in the sector are muted and rental growth is likely to remain generally weak outside of the most prime assets and areas where supply is limited,” says the team. “Despite that, there are opportunities for disciplined stockpickers and we continue to look for companies with the capacity to grow rents and create value despite the difficult economic outlook. 

“This focus on quality holdings with robust balance sheets and proven management expertise should stand us in good stead against a muted growth backdrop, with nominal cash yields attractive compared with historical levels and other asset classes.”

Aberdeen noted a fall in property shares in June, in line with the broader European markets, which belied a rebound in UK commercial values in May – the first increase in 18 months.

Looking at other top performers in the property equity sphere, several have used their global mandates to extract maximum returns from the sector.

JPM Global Property Securities, managed by Kay Herr and Jason Ko, has Japanese exposure to thank for much of its recent performance. The managers say the portfolio has underperformed in recent months, with stock selection in the US, China and Singapore all hitting returns.

“A lack of exposure to the Nippon Building fund was the largest stock-level detractor, partially offsetting the positive contributions from other Japanese stocks,” they say. 

“Performance in Japan, Hong Kong and Canada accounted for the largest positive contributions to relative returns, with stock selection and allocation beneficial in all three markets. The largest single positive contributors by far were all in the Japanese market, with Nippon Prolgis Reit, Japan Real Estate Investment Corporation and Mitsui Fudosan all adding value.”

Herr and Ko believe that even in a pro-cyclical, risk-on environment, Reits continue to offer an attractive blend of bond-like yield and potential equity-like upside. 

They say: “Reits realise continued internal growth or organic growth in cashflow and dividends from their underlying portfolios.They are able to tap into the capital markets in order to make acquisitions, offering opportunities for external growth.”

Schroder Global Property Securities manager Jim Rehlaender says his outlook for 2013 remains intact but the timing of a concerted rise in Reit markets around the globe is being pushed out to later in the year. 

“Unanticipated macroeconomic travails in China and Europe have investors searching out safe havens in US financial markets, with returns there consequently exceeding our expectations and significantly outperforming international markets. Global Reits now trade at about a 1 per cent discount to the value of their underlying portfolios while US Reits trade at a 14 per cent premium. Given low levels of supply in most markets and measured demand growth, fundamentals for higher-quality property are relatively healthy,” says Rehlaender.

Rehlaender remains constructive on the fundamentals of Asian real estate and continues to view valuations as attractive although he is closely monitoring government intervention. 

He says: “With the US seemingly on the road to recovery, our outlook for 2013 remains positive on the view that economic fundamentals are likely to improve over the year, which should lead to a wider positive impact. 

“Looming shortages globally are driving property company share prices higher, while the sector continues to benefit from sustained low interest rates and inflation.”

Returns from bricks and mortar funds are considerably lower but entirely in line with their asset class and its fairly tough environment of recent years. 

These funds also have to hold around 25 per cent of their assets in cash to deal with any redemptions, creating a drag on returns.

Henderson UK Property is among the stronger direct portfolios in the sector, with co-manager Ainslie McLennan noting growing interest in the asset class as investors search for yield. 

“There is a healthy weight of money looking to be invested into the market and an increase in investment transactions. 

“The market is seeing the more speculative funds and private investors moving up the risk curve and buying into historically high secondary yields, particularly in areas and sectors where there have been years of little or no development. 

“Occupationally, life is still hard for many companies that form the UK tenant base. The focus for the fund, resultantly, remains on holding businesses as tenants that have strong credentials and that are likely to be relevant not only now but in the future,” says McLennon. 

Like many of its peers, Henderson UK Property is biased towards the South-East of the UK at 71.7 per cent of assets and has an underweight in retail.

Ignis UK Property is another solid bricks and mortar offering in the peer group, with a fairly stock-specific approach and a focus on enhancing income streams from the selected assets. 

This fund’s UK exposure is also skewed to the south-east, excluding central London, with a bias towards industrials. 

Its manager George Shaw says: “The established pattern of the current cycle continues as income remains the driver for total returns. The retail sector continues to see the highest levels of capital decline, together with mild rental falls. 

It faces major challenges given the fundamental changes brought about by the expansion of online sales and weak disposable income growth in the wider economy.

“As capital values continue to stabilise, we consider the fund to be well positioned due to the prime nature of its assets, diversified tenant base and significant exposure to central London and south-east markets.”

Best and worst performing property funds to 29 July 2013
Best and worst property funds over three years
Top 5
Fund                                                                 Total return  %
Aberdeen Property Share                              62.1
First State Global Property Securities         43.2
JPM Global Propery Securities                     41.6
Premier Pan European Property                   40.6
Fidelity Global Property                                39.8
Bottom 5
Fund                                                                Total return %
Aviva Investors Property Investment         -15.8
Threadneedle UK Property                           2
Aviva Investors Property Trust                    2.1
Scottish Widows UK Property                     3.8
SJP Property                                                  4.8
Sector average                                               23.3
Figures are for the three years to 29 July 13 and based on total returns on a bid to bid basis with net income re-invested.
Source: FE Trustnet