With interest rates stuck at record lows and dividends under pressure, the search for investment income has become harder than ever. Fortunately, bonds have seen yields improve, offering one alternative for investors, but what about commercial property?
Traditionally, the asset class has provided a stable stream of income, but with hotels and leisure centres shut, car show rooms and shops only slowly opening, and question marks over the future of office spaces, is it still a viable choice?
As an investment team we felt pre-crisis that property was, like a number of other asset classes, looking a poor investment from a valuation perspective – with yields also suffering. There were also (and still are) a number of structural challenges occurring in the sector due to digital disruption. The only area we were invested in was student accommodation, care homes and social housing – where the supply and demand, as well as the yield, made them solid, attractive investments.
How much damage has been done?
Every asset class has been hit hard by the coronavirus – but property has suffered more than most. We’ve seen a number of open-ended funds close their doors once again – albeit this time it’s a technical, rather than a liquidity closure, over the inability to value correctly. Once these funds open, we can expect to see adjustments downwards in price. In addition to this, some of the property trusts are still trading at a 50% discount.
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Looking forward, it’s going to be a case of evaluating the sub-sectors each fund or trust invests in to see how much damage has been done. In a recent catch-up with TR Property Trust manager Marcus Phayre-Mudge, he pointed out that the sectors which perform best on the way down in a crisis are also the best performers when the market bounces.
Marcus, who also manages the BMO European Real Estate Securities fund, is positive about those sectors where the income has been secure, probably index-linked, and where landlords have been able to recover the rents from tenants. He cites the likes of healthcare, nursing accommodation, supermarkets, logistics and industrial property – all of which he expects to pay a full year’s dividend.
Office space splits opinion
The one sector which seems to split opinion to a greater degree is office space. There is a general expectation that people will work from home more as a result of the pandemic, but could that be a knee-jerk reaction? Premier Pan European Property Shares fund manager Alex Ross says he expects corporates to require fewer workstations in their office space in the future, but in many cases, this won’t necessarily lead to less space required, just better-quality space. He says the result will be a “material divergence in rents between the dynamic and flexible grade A buildings, which are also highly energy efficient, relative to the large floorplates of generic office buildings as often seen in the City or Canary Wharf”.
Brooks Macdonald Defensive Capital fund manager Niall O’Connor says he is specifically avoiding offices as a property sub-sector until the outlook becomes much clearer. He also feels the move towards working from home will be offset by the need for more space due to social distancing and less hot-desking.
Property has a strong attraction as an income play and we are sticking to the areas where we have found tried and trusted sources of returns. The TR Property fund, which offers a yield of 4.1%* is a good example of such a trust. It invests in Pan European equities and UK direct property, focusing on long-term capital and income growth. Another which we’ve added to our managed range is the Supermarket Income Reit – which looks to offer access to long-dated, secure, inflation-linked income with capital appreciation potential over the longer term. It has a valuation yield of 5%**.
*Source: Fund factsheets, 30 April 2020
**Source: Provider website, 12 June 2020
