Is property off the investment naughty step?
There are signs that a number of multi-asset managers are moving back to the sector after it has spent five years on the equivalent of the investment naughty step.
But are they choosing open-ended or closed-ended funds? And after some solid performance in the sector, are there still gains to be made?
Among those moving back into commercial property has been Mark Burgess, chief investment officer at Threadneedle, who says that the asset class has been the one area not yet to benefit from the vogue for yielding assets: “(For) UK commercial property…the yield is still over 6%. If one considers the fundamentals; the UK economy is slowly improving and is unlikely to return to recession. The banks have improved their capital positions and are not the forced sellers they once were. In addition, private sector buyers, particularly from overseas are now buying portfolios of real estate from the banks attracted by the returns on offer.”
Burgess had held a long standing underweight position, but has now taken the decision to move modestly overweight property, adding: “On a 5 year view, even allowing for the sizeable transaction costs, we feel the returns on offer, particularly from a yield perspective, make this a good time to increase our exposure to this asset class.”
Burgess is not alone. Bill McQuaker, head of multi-asset at Henderson Global Investors, says he has upped his commercial property weighting in recent months, investing in bricks and mortar property funds for the first time since the crash.
He believes the yields available on commercial property look attractive as an alternative to bonds: “There is also not the same crowding in commercial property as there is in the bond market. If people disengage from bonds and the money comes out, it could be quite painful, but people haven’t gone back into commercial property after the crisis of 2007-2008.”
The last set of IMA statistics showed £98m in net new retail money moving into the property sector. This was some way short of that for the top-selling UK Equity Income sector at £358m, but nevertheless showed some change in sentiment towards the sector. iShares also reported that flows into REITs surged in the first quarter of the year and reached a record not seen since before the crash.
However, there are signs that the low-hanging fruit in the property sector may already have been picked. Property share funds, in particular, have had a strong run of performance, particularly those with international exposure.
This is not simply because shares tend to anticipate higher returns, whereas valuations from bricks and mortar funds take time to catch up – there have been strong structural reasons for the outperformance of property companies over bricks and mortar funds.
Alex Ross, manager of the Premier Pan-European Property fund, says that Reits have been able to take advantage of the low interest rate environment to boost earnings: “The major Reits have a unique cost of capital advantage.
“They have been able to tap the corporate bond market and raise 5-6 year bonds paying a coupon of just 1.5-3%. They can borrow at these low rates and generate far higher returns on their income. It has been highly earnings accretive for them.”
He says that many of these property companies are also benefiting from a re-pricing of real estate, particularly in the major cities, such as London, Paris and Berlin. Bricks and mortar funds have benefited from the re-pricing of real estate, but not – in general – from the lower cost of capital.
Tom Tuite Dalton, an analyst at Oriel Securities, says: “The direct property funds have underperformed. Even the best performing direct property fund – F&C Commercial Property – whose management shrewdly focused on prime locations and on London’s West end in particular has not performed as well as the TR Property trust over 1,3 and 5 years.”
The top 10 funds in the IMA Property sector over three years are all property security funds, and have all delivered over 30% over that period.
So is there still value now? Ross is clear that prudent selection of individual vehicles will be vital from here in a property market where yields are likely to flatline. In particular, he believes those Reits that can generate rental growth will create greater value for shareholders. His fund is focused on the London ‘tech belt’ on the fringes of the City, where there is considerable redevelopment, and also on strong secondary property in the regions.
Others are not as sure that the sector still has value. Caspar Rock, chief investment officer at Architas, says: “We have around 10% of our benchmark in property. We have been underweight for some time, but have been marginally closing out that underweight position. Property seems to be getting less bad, but some of the property investment trusts are already trading on significant premia, so the market may well be discounting those gains.”
For example, the top-performing F&C Commercial Property trust currently trades on a 13.9% premium to net asset value.
The open-ended bricks and mortar funds have not seem the same strong run of performance and therefore may offer more potential capital upside. However, they also do not have the same cost of capital advantages as some of the property companies.
Nevertheless, for some multi-asset managers diversification – particularly away from fixed income – is part of the reasoning behind increasing their property weighting. Bricks and mortar property funds, with their higher yields and better diversification characteristics may be a better option on those grounds.
The property sector has undoubtedly had a small renaissance, but those examining the sector now may have missed the early gains. Property share funds have had a good run, and bricks and mortar funds do not have some of the structural advantages that have boosted the Reit market.
However, for those investors looking to commercial property as an alternative to weakening fixed income markets in a climate where the Federal Reserve may be drawing quantitative easing to an end, valuations do not look nearly as stretched and yields are still attractive.