Revamped Value & Income says index-linked property still 'seriously undervalued'

The trust, which now goes by Value & Indexed Property Income, says stagflation is here to stay, creating a major opportunity in real estate with inflation-linked rents.

Value and Indexed Property Income (VIP ) has almost completed its portfolio shake-up, which managers Louise Cleary and Matthew Oakeshott say takes advantage of the ‘seriously undervalued’ index-linked market.

It has been a year and a half since company founder Lord Oakeshott proposed the trust drop its longstanding dual investment policy in UK equities and property to focus solely on UK real estate long leases with index-linked rent reviews, rising in line with inflation.

The decision to follow through with the strategy has led to a turbulent period, with more investment activity than usual and underperformance in the year to 31 March. Over the year, the fund delivered a net asset value (NAV) of 15.6% versus a total return of 19.6% from the benchmark MSCI UK Quarterly Property index, annual results reported. 

Despite lagging the index, the new strategy has helped the fund maintain its ‘dividend hero’ status – a key aim of Oakeshott’s proposal – increasing the pay-out for the 35th consecutive year, with the dividend up 2.4% at 12.6p.

Cleary and Oakeshott (pictured) warned that ‘Britain is now suffering stagflation’, an unforgiving mix of high inflation and stagnant economic growth, and that looks here to stay for as long as the war in Ukraine continues to drive energy and food prices higher, meaning index-linked income is ‘still seriously undervalued’.

‘Safe, long-term indexed income will be even more highly prized as inflation rises faster for longer than myopic markets and complacent central banks expect,’ said the managers.

‘Wars are always inflationary, and however long the war lasts in Ukraine, the West is clearly now in an economic cold war with Russia and its allies, with sanctions and shortages biting for years to come.

‘Secure, index-linked, UK property offers massive yield margins over index-linked gilts, and a comfortable yield cushion still over conventional bonds.’

The ‘stark lesson’ property investors learned from the Covid-19 crisis still remains true, said the duo: ‘Stay on the right side of structural change, avoid offices, and stick wherever you can to properties let to strong tenants at affordable rents on long, preferably index-linked leases.’

They said the performance of offices is going ‘from bad to worse’ with the market now ‘locked in long-term relative decline’ as the pandemic changed the way businesses work for good.

‘Offices have taken over the performance wooden spoon from retail for the first time in 12 years and may hold it for the foreseeable future,’ said Cleary and Oakeshott.

The pair were equally downbeat on the prospects for industrials despite the hot sector continuing to see high demand from tenants and investors until a recent slowdown. 

The managers believe the market is ‘overheated’ and said ‘yields have fallen far enough’ as property changes hands at ever-higher prices.

‘Warehouse and industrial property delivered most of commercial property’s total capital growth in 2021 for the right reasons, with voracious demand, mainly from food and online retailers, driving up rents right across the UK,’ they said.

More than £18bn was invested in industrial units and warehouses in 2021, double the 2020 volume, and 60% above the previous highest annual level recorded in 2017.

However, the pair said this means the industrial sector is ‘now running white hot, too hot in our view, with yields bid down to unsustainably low levels by panic buyers, who are having to make wholly unrealistic rental growth projections to justify the prices they are paying’.

The remaining UK equity portion of the fund benefited from an uplift in property stocks that saw it deliver a total return of 24.1%, beating the 13% recorded by the FTSE All-Share and the 22.5% return from the FTSE All Share Reits index.

Equity manager Patrick Harrington said the fund benefited from high exposure to its new investments in industrial property, and from the strong performance of two food retailers, Morrisons and Tesco (TSCO). The former was taken private during the year in a blockbuster deal, generating a profit of £1.5m for the fund.

However, on the view industrials are overheating, Harrington sold out of three large industrially-exposed players in the year, ditching Tritax Big Box (BBOX ), Urban Logistics (SHED ), and Warehouse Reit (WHR ) for ‘a good profit’ when their shares were trading at a premium to the latest published asset values. 

The proceeds were partly reinvested into BMO Real Estates Investments (BREI ), which has switched its strategy to focus on industrials and retail warehouses, at a discount of 25%.

Investment company news brought to you by Citywire Financial Publishers Limited.