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High Rise in the Property Market? Report shows real estate growth

31 May

Real estate is undergoing what might be cautiously stated a resurgence. A chart from IPD Annual Digest, 2012, cited in a recent Clearpath Analysis report by Kames Capital, tracked the underlying growth in received income from property back to 1981: though it plunged into negative growth 2008-9, a steady subsequent increase means that from 2012 its course has been continuously positive.

Earlier in 2013, a report commissioned by the IPD and published by a research team at Cambridge University tested the diversification benefits of property within a multi-asset portfolio. The authors of Real Estate’s Role in the Mixed-Asset Portfolio: A Re-examination, 2012, Cambridge University, announced that “the research confirms that real estate – both private and publicly-listed – does offer diversification benefits in a mixed-asset context. While they did diminish, those benefits did not disappear in the difficult market conditions that followed the onset of the global financial crisis.”

In a white paper on property which Kames Capital’s Phil Clark contributed to the Clearpath Analysis report, he highlighted the way capital growth from real estate increases in both rental value, and market capitalisation (though obviously the two are linked). However, unlike dividends where the revenue stream is dependent on the company’s discretion, with property it is contractual. “As with bonds, the capital value of future income stream depends on market sentiment, but is less certain than a bond’s par value, albeit with upside potential from capital­ growth,” said Clark.

Clark pointed out that currently the majority of portfolios are 5% under-weighted in property compared to normal market conditions, a trend he believes is starting to reverse with the move away from fixed-income securities.

I talked exclusively to Rob Martin, head of research in L&GIM’s Property division. LGP is the third largest institutional property fund manager in the UK, managing or co-managing 16 separate funds or vehicles, and two segregated mandates with an aggregate asset value of £10.6bn as of 31 March 2013. Most products within its catalogue are open to retail but predominantly institutional investors, and include eight balanced funds where the portfolio is weighted by region and/ or industry, as well as specialist pooled funds and single asset vehicles.

Martin notes there has been a definite rise in interest in property from defined benefit (DB) pension schemes over the last 10-12 months, but especially since the start of 2013. The insurance sector of L&GIM has also upped its allocations. This he attributes to the high yields in comparison to falling yields from the equity and particularly the bond market, in which investor interest and volatility is now contracting.

Making the most of the current opportunity is about “smart portfolio structure – finding the right parts of the market at the right parts in the cycle.” For those seeking the ‘tactical opportunity’ in real estate, Martin points to “office spaces outside of London” as the latest hot spot where returns are rising fastest. LGP is currently engaged in bringing forward a number of significant town-centre retail and leisure regeneration projects, including Bracknell, Trowbridge, Milton Keynes, Northampton, Hounslow and Eastbourne. You might also recognise its guiding influence in West End landmark building, Central Saint Giles; and Agar Street, its high profile Covent Garden office scheme.

So much for ‘beta’ market-determined returns, but for additional ‘alpha’ yields in property, managers must perform continuous asset due diligence and intensive asset management. Martin divides these broadly into enhancing occupation of property, and refurbishing the property. To improve the occupiers’ experience, L&GIM takes what he terms a ‘matey’ approach, cultivating close relationships with commercial tenants and ensuring demands are met. He gives the example of a shopping centre where one tenant who decides they need more space might be swapped with another who is downsizing. The end aim is to preserve the occupancy and the goodwill of the client – as well as minimising loss of revenue. Renovations through refurbishment are common, and they also engage in knocking down existing buildings, or buying land, to create new purpose-built properties.

As regards the type of property, Martin discloses the Property department is looking to branch out into a residential allocation; currently the bulk of their portfolio consists of industrial or commercial holdings, as well as the lucrative sectors of student accommodation and healthcare and social care facilities. These last two are popular because yields have a low market correlation, depending instead on population demographics or government policy. Martin also reveals that L&GIM is investigating infrastructure investment, whose risk profile, level and tenor of return on initial investment are so similar that both categories are increasingly grouped under the term ‘real assets’. Infrastructure, he admits, is “one of a number of initiatives that we are looking to incorporate into the business. It is a very natural bedfellow for real estate.”

There are downsides to property, in addition to its illiquidity which he concedes will always deter those reluctant to tie their earnings to a decade-long scheme. He stresses the high allocation of budgeting for due diligence, saying “You need to invest time in understanding the particular risk profile of a property.” Another consideration for those seeking to build a direct property portfolio, with ownership of the buildings, is that “You need a large allocation, somewhere between £300-350m in order to achieve the proper level of diversification.” Though he concedes that by investing in a fund you do lose some control over your investments.

Buy British, and invest in one of several dividend choices from British Land

25 Mar

The British Land Company is offering a 3rd interim dividend of 6.60p, up from its standard interim dividend price of 6.50p for 2011/12. It is also offering a SCRIP scheme, for which the price has not yet been made public. This cautiously optimistic picture is reflected throughout the company’s core financials.

Net yields from its portfolio, as of 30 September, are highest for European retail (6.7%) and provincial office space (7.2%). All figures cited here include rent contracted from expiration of rent free periods, and fixed uplifts not in lieu of growth. Within the UK, department stores (5.9%) and retail parks (5.6%) were the most lucrative forms of retail space, while superstores returned a poorer 5.1% yield. The value of retail parks has increased by 2.3% over the last year.

Commercial office space in the West End and the City yielded 5.5% and 6.0% respectively, though if you exclude revenue contracted in advance, the figures fall to 4.4% and 4.1%. Demand for West End office space is crowding out new contenders in the market, as prices have shot up by 3.2%, more than double the price of office space in the other two categories. This explains the diversification into business districts outside London, something predicted in a widely read report by Deloitte on 2013 predictions for the property market.

The report foresaw that the pricing barrier of prime stock for investors would mean increasingly that “returns fall below required hurdle rates”. It emphasised the role of foreign investors in developing “funds that were new to the market 3-5 years ago, (which) have since built up significant experience… and some will inevitably seek to translate this into the higher income returns found outside prime income markets.”

British Land has a healthy share of debt, from various sources, which it cites as a major source of liquidity for future acquisitions and developments. Image

Despite gross and net borrowings of £2,758m and £2,557m respectively, its interest cover on its debt is 2.9X (loan to value of 32%). It elaborates, “Including our share of debt on joint ventures and funds which are neither wholly owned nor fully consolidated, gross and net borrowings were £5,195m and £5,071m at the same date. These borrowings are non-recourse to British Land and are in ‘ring-fenced’ structures.” Its interest cover on the latter is a less rosy 2.2X.

However, it is confident in its future prospects, with “further pre-letting activity with office developments now 62% pre-let or under offer; 76% in the City.” And the large-scale Whitely Shopping Centre retail scheme is now 85% pre-let or under offer in advance of its May opening.