Income from property trusts will play an even bigger part in total return as prices stagnate, say fund managers.
With commercial property values stagnant, yield is becoming increasingly important and managers are turning to defensive logistics to help protect income during the Brexit storm.
UK commercial property headwinds show no signs of abating as the Brexit deadline is rolled on, the country faces a general election, and the slew of high street store closures continues apace.
The uncertainty caused has subdued the real estate market, with transaction volumes down 27% year-to-date.
The £10.7 billion invested in UK commercial property investment companies is currently yielding 5.1%, and managers have said income will make up a greater proportion of total returns.
Peter Lowe, manager of the BMO Real Estate Investments (BREI) real estate investment trust (Reit) that is currently yielding 5.8%, said income is still ‘60% of total return’ but ‘capital values now are at best flat so income will become a bigger part of total returns and this has an impact on stock selection’.
Lowe has been positioned the £209 million trust towards the industrials sector, which now accounts for 40% of the portfolio, to give it ‘added defence on the income side’, noting the likes of Amazon are signing 20 to 25-year leases on logistics plays like warehouses.
Logistics in demand
Will Fulton, manager of the £1.1 billion UK Commercial Property Reit (UKCM), which yields 4.1%, has also shifted his portfolio into logistics, selling out of retail in order to purchase industrial property, which makes up 48% of the trust.
‘In 2015 we had 45% in retail but we have sold £200 million [of retail property] and bought £200 million of industrials,’ he said, adding that retail now made up around 20% of the trust.
‘Urban industrials and urban logistics is a massive engine for growth but it is very expensive for new entrants, and by owning it we’ve seen big increases in rent.’
Fulton added that while London was the ‘driving force in rental growth’, he is also interested in the ‘core area of the Midlands’, as the central UK location means it is a key distribution hub for e-commerce businesses.
As well as reducing retail property for the last three years in order to invest in industrials, Fulton has offloaded London offices to bolster the logistics portion of the portfolio.
‘We do not have many offices in London as we are worried about the political risk,’ he said.
Lowe said the London office market was one part of the property market likely to be put under political pressure not just from Brexit but also from the risk of a Labour government coming to power after the 12 December election.
He said a Labour government would have a detrimental effect on real estate as it ‘may raise gilts and squeeze out margins’.
‘The market will look vulnerable,’ he said, adding that London offices were particularly vulnerable due to ‘a [Labour] rhetoric around financial services that is not helpful’.
‘Urban logistics is more resilient which is why we like it.’
He added that in the event of a hard Brexit, warehouses and logistics would benefit from the need to ‘stockpile’ food and supplies, while under a soft Brexit deal, relieved consumers would still want to shop.
There may be many issues facing the sector but one tailwind is a slowdown in the construction industry.
Lowe said the cost of construction had risen, including labour and land, and ‘we are not seeing developments because they cost more to build’.
‘This is good for existing owners because tenants are forced to take the stock that there is,’ he said.
He added that despite the ‘general malaise’ in the retail market, property was benefiting from ‘lower for longer rates’ and an ‘absence of late-cycle behaviour’.
Fulton, who said he favours ‘sectors that provide more durable and defensive income qualities’, said excepting retail the occupational market was ‘generally stable’ and there was still strong rent growth in prime urban areas, particularly in London and the South East.
‘We see selective opportunities arising in the alternatives sectors and expect interest in more operational sectors, which provide greater exposure to the underlying performance of income-generating assets, to increase,’ he said.