Solid Property Funds for Investors Seeking Yield

Direct UK property funds have struggled to outperform but there is a handful of attractive funds for investors seeking yield from property

Muna Abu-Habsa 12 June, 2013 | 4:15PM
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The polarisation in the valuations of prime and secondary property assets has continued to dominate the returns of property funds over the last few years. Central-London safe havens and primary assets outside of these remain in vogue while secondary assets have been repeatedly discounted by valuation agents, increasing their yields. Overseas investors have continued to focus on prime London properties that have been delivering robust rental growth, buoyed by their limited supply – an area that is challenging for retail property funds to get sufficient exposure to given the hefty price tags attached. 

Yield Does Not Equal Income

This pattern does not surprise us. As authorities around the globe have used aggressive monetary policy to boost their struggling economies, investors have found difficulty in generating income from traditional sources such as cash and bonds. With a near 6.5% yield (according to CBRE) and record yield gaps relative to bonds and cash, property has been an attractive hunting ground for income-starved institutions. Indeed, relatively weak economic data and financial repression have kept government bond yields at low levels and below headline and expected future inflation rates, suggesting medium-term returns could well be negative. Although investment grade corporates offer better value, yields are also at all time lows.

However, one must tread cautiously and investors should remember that yield is not income. The yield is the income distribution as a proportion of the capital value.  If we compare the 6.5% yield on property with a 10-year BBB bond that is now yielding around 4%, then the spread illustrates a compelling case for property. Nevertheless, this attractiveness is somewhat diminished by falling capital values. Indeed, the decline in UK commercial property capital values continued to gather pace this year, with all three main UK commercial property sectors continuing to decline; namely the retail, offices and industrial sectors. Reassuringly, this pattern is expected to reverse during the course of the year, with investment houses forecasting a low single digit increase in capital values over the next 12 months. 

3 Solid Property Funds

For investors seeking property exposure, there are some solid UK property funds available. At Morningstar OBSR, we closely monitor a number of these, including M&G Property Portfolio, which we consider to be a high quality proposition. Threadneedle UK Property Trust offers a different flavour of property investing. It focuses on higher yielding assets which are often just outside the prime real estate category. We also have high conviction in the lead managers of the Legal & General UK Property Trust who are highly skilled and benefit from the backing of a well-resourced property team.

Investors should note, however, that on average direct UK property funds have struggled to outperform the IPD UK All Property Index through time. The reasons are twofold. As the IPD index continues to rise, substantial cash holdings in funds – necessary to fund outflows, acquisitions and developments where applicable – have remained a drag on returns in the environment of very low interest rates in the UK. Also, the index does not account for any fees or transaction costs, and these act as an additional obstacle to fund returns.

REITs Offer Appeal 

Real estate investment trusts (REITs), on the other hand, have been an appealing place to be, with UK REITs returning around 30% last year and another 6.4% so far this year. As in most other sectors, the place to hide has been in quality assets and companies with strong balance sheets. Following substantial recapitalisation, the main UK REITs fit the bill. Newsflow from the majors has remained positive and decent earnings momentum and above average yields continue to attract buyers. However, investors should be aware that their status as traded securities, and in some cases the use of leverage, makes the investments much more volatile than Direct Property. For example, in 2011 these came under pressure as the markets took a turn for the worse in the summer. While a large divergence can be seen in the performance of direct- versus indirect property investments in the short-term, through time listed property assets have broadly kept pace with property prices. 

This Morningstar article was first published in Investment Adviser and FTAdviser.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
M&G Property Portfolio GBP R Acc102.04 GBP0.12

About Author

Muna Abu-Habsa  is a senior investment research analyst at Morningstar

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