08:00 Wed 20 Jan 2010
Investment Line: Is it too late to ride the commercial property recovery?
Commercial real estate is showing signs of emerging from a two year slump, but are the uplifts in the Net Asset Values (NAV) a buy signal for the closed-ended property sector?
UK commercial property capital values rose over the third quarter of 2009 by 1.5%, a 5.6% improvement on the previous quarter according to statistics from the IPD UK Quarterly Property Index, and the signs are that the majority of UK property porfolios saw even bigger gains through the last quarter of the year.
Last week, the Ignis run UK Commercial Property (Ordinary Share) trustthe largest listed closed ended UK property fund-reported a 10% rise in its property portfolio for the three months to the end of the year. Broker Oriel estimated the Net Asset Value would rise to around 74p from 67.7p at the end of September.
Standard Life Property Income (Ordinary Share) saw its property portfolio rise in value by around 5% for the same period while F&C Commercial Property (Ordinary Share) also posted a 10% rise in gross portfolio assets.
Are there uplifts sustainable or have investors missed the best of the recovery and the ensuing share price appreciation that has gone with it?
Winterfloods analyst James Brown says he expects to see further rises in Net Asset Values in the sector during the first quarter of 2010 but that further out, the scenario is less likely as economic uncertainties cast a shadow over the UK market.
There are two main reasons why NAVs have bounced over the last quarter according to Brown.
The first has been the huge inflows into open ended property funds over the last few months, which has driven fund managers to acquire commercial property.
The second has been the search by income investors for meaningful yields.
'This has kicked off transactions and pushed up prices,' says Brown.
He expects a further-albeit lesser rise-in the first quarter's NAVs, and a little more in the second quarter. After that, he thinks asset rises are likely to flatten.
'I expect to see risks beyond the next four to six months because the fundamentals of the property market are unlikely to support sustained rises. There will still be concerns over vacancies in the commercial property market as rentals come up for renewal and if interest rates start to rise it will be hard to sustain yields.'
Brown is slightly wary of trusts such as veteran Chris Turner's TR Property (Ordinary Share) and Henderson Global Property, as they are both primarily property equities buyers, and he sees challenges ahead for the listed property despite both trusts being well-run.
Charles Stanley's head of investment trust research Stephen Peters agrees with Brown's analysis of what has been happening on the ground.
'With the open ended property funds reopening, there has been a massive wall of cash pushing up lot prices in the UK as companies need to get their cash into the ground.
'Closed ended players like Invista are seeing excess yield compression in some areas and lots of trusts have gone to premiums once people realised the sector was not going to go bust.'
Brown says two to watch are Standard Life Investment Property Income and ING UK Real Estate Income (Ordinary Share) which both have around 50% gearing.
'If underlying values spike they may well outperform.'
Brown is currently wary of Close High Income Properties (Ordinary Share) , another heavily geared property trust. It is still trading at around a 50% discount, reflecting the lower standard of its property portfolio and is not paying out a dividend.
For yield hunters, most trusts in the sector are paying out yields of between 5 and 8%. Brown says he is currently steering clear of Invista Foundation Property from an income perspective.
Peters says the likelihood of income tax and VAT rises after the next election will also put pressure on commercial property yields.
Despite this, he says Invista have identified some selective undervalued pockets of commercial property in the City of London, compared to the more overheated West End office market,where he sees more potential uplift.
He picks UK Commercial Property (Ordinary Share) however as a relatively safe investment in the sector as it has no gearing issues, while for the slightly more adventurous, he picks Invista Foundation Property (Ordinary Share).
'The dividend is only about 70% covered but it is interesting as it has cash to invest and they are good asset managers, who actively manage it and move tenants around.'
With Invista now at 44p after launching at 100p, Peters says it is hard to describe those who have not invested over recent months as having missed the boat.
Yet he does believe most of the share price appreciation of the last few months is now over, even if yields now look a little more solid.
'Investors have missed the majority of share price appreciation, but I think yields look more sustainable now than they were. I don't think we will see further big rises in NAV but we should see a solid steady progression.'
Investment company news bought to you by Citywire Financial Publishers Limited. 