How to research commercial property funds

London skyline

Last week this column looked at the UK commercial property sector and did so from the perspective of quoted property development and management companies known as Real Estate Investment Trusts (or REITs).

This was because commercial property stocks have begun to perform better after a lengthy period in the doldrums following the UK’s referendum vote to leave the EU last June.

That decision sparked fears of an economic downturn and rush for the exit by financial services firms unable to ‘passport’ their products in the EU under the bloc’s rules, to the potential detriment of commercial property valuations and rents.

Yet such fears have yet to be realised and, as noted last week, four factors may have started to stir fresh interest in UK commercial property:

  • UK Government bond yields have plunged from their February peak above 1.40% to barely 1.10%, again leaving investors looking for reliable sources of income, with property firms and their rental income streams one option to consider, especially as those rents are then often turned into juicy dividend payments to shareholders.
  • Several high-profile property deals in London have confounded the sceptics, as they buildings were sold at or even above their historic book value. The ‘Cheesegrater’, or the City of London’s Leadenhall Building to use its proper name, Vauxhall Square and Olympia are all examples of deals which suggest valuations are holding up well and not falling in the manner expected when property shares collapsed and property funds shut up shop last summer.
  • The buyers in the deals above were Chinese and German, while the Sunday Times newspaper has reported that a Hong Kong billionaire has built a big stake in FTSE 250 property company Shaftesbury, with a view to making a bid. The weak pound may be again tempting overseas buyers.
  • Finally, many stock-market quoted property developers and managers still trade at big discounts to net asset, or book, value, to suggest they may still be too cheap, in light of the deals outlined above and the possible bid for Shaftesbury.

Yet not all investors will wish to take on the risk of buying specific property company shares, because they do not have either the time or inclination to research them thoroughly.

For them, a fund may therefore be one way to get exposure to commercial property while managing risk, providing investors feel that the overall asset class is suitable for their overall investment strategy, target returns, time horizon and appetite for risk.

Property investment trusts

The next table shows how the managed investment trusts which invest directly in UK property generally trade at a premium to net asset value (NAV).

This is a marked contrast to the REITs who form part of the FTSE 100 and FTSE 250 stock market indices, where discounts to net asset value (NAV) are the norm, at least for those property stocks with exposure to the development of new sites and buildings, the City and financial services, London more generally or (in some cases) all three.

The higher ratings enjoyed by the investment trusts may reflect their lack of development exposure and also the geographic and industry mix of their tenants (between finance, retail and industrial).

The one exception is the investment trust which invests not in buildings but the shares of the REITs:

Property investment trusts are generally trading at a premium to NAV

Property Direct UK Premium/(Discount) to NAV Dividend yield Gearing OCF
Standard Life Property Income 11.4% 5.5% 45% 1.49%
F&C Commercial Property 9.3% 4.2% 28% 1.18%
Picton Property Income 6.5% 4.0% 48% 1.10%
F&C UK Real Estate 6.4% 4.9% 42% 1.67%
LXI 6.4% 2.9% 0% n/a
AEW UK  5.8% 8.2% 12% 1.48%
Schroder Real Estate 3.7% 4.0% 41% 2.50%
Drum Income 2.5% 5.7% 25% 3.11%
UK Commercial Property 1.6% 4.3% 2% 1.49%
Ediston 0.1% 5.0% 29% 1.64%
Regional -2.4% 7.6% 35% n/a
Sector average 5.3% 4.6% 26% 1.49%
Property Securities
TR Property -12.3% 3.0% 14% 1.14%

Source: Morningstar, The Association of Investment Companies, for the Property Direct – UK and Property Direct – Other categories

The investment trusts will offer a similar diversity of portfolio, to help investors mitigate risk and careful research will reveal which trust is more exposed to financial, retail or industrial sites.

However, the valuations on offer are high relative to the averages seen since 2005 (a period that encompasses the deep and frightening downturn seen during the Great Financial Crisis of 2007-09).

This suggests investors are still prepared to pay up for the income on offer in the form of the dividend yield, which they clearly see as sufficiently dependable (or attractive relative to cash or Government bonds) to merit paying a premium to NAV.

Property investment trusts are generally trading valuations that are high relative to post-2005

Property Direct UK Premium/(Discount) to NAV Post-2005 average*
Standard Life Property Income 11.4% -0.1%
F&C Commercial Property 9.3% 0.8%
Picton Property Income 6.5% -13.8%
F&C UK Real Estate 6.4% -4.9%
AEW UK  5.8% 3.2%
Schroder Real Estate 3.7% -11.5%
Drum Income 2.5% 15.2%
UK Commercial Property 1.6% -0.4%
Ediston 0.1% 1.1%
Sector average 5.3% -1.2%

Source: Company accounts, Thomson Reuters Datastream, Morningstar, The Association of Investment Companies, for the Property Direct – UK and Property Direct – Other categories

Note that the investment trusts do use gearing – or borrowing – to help to enhance portfolio returns (although this can also accentuate any losses during downturns), although the average figure of 24% across the sector is on balance lower than the average loan-to-value ration seen across the quoted Real Estate Investment Trusts, as the subsequent table shows:

Property investment trusts’ gearing levels are lower than those on offer at the major quoted property development companies

Investment companies Real Estate Investment Trusts
Property Direct UK Gearing (%) Gearing (%) Loan to Value (%)
AEW UK  12% British Land 49% 32%
Drum Income 30% CLS Holdings 85% 50%
Ediston 29% Derwent London 23% 18%
F&C Commercial Property 29% Great Portland Estates 26% 16%
F&C UK Real Estate 42% Hammerson 59% 41%
LXI 0% INTU 86% 44%
Picton Property Income 47% Land Securities 29% 23%
Regional 35% Londonmetric Property 69% 36%
Schroder Real Estate 41% Shaftesbury 33% 26%
Standard Life Property Income 45% Town Centre Securities 99% 50%
UK Commercial Property 2% Workspace 17% 14%
Sector average 26% Sector average 52% 32%
Property Securities
TR Property 14%

Source: Company accounts, Thomson Reuters Datastream

Property funds

By way of information, the next tables list the best performing property (closed-ended) investment trusts and (open-ended) funds.

In the latter case, all of the funds which closed and suspended trading or downwardly-adjusted their net asset values have recommenced dealings. These included Aberdeen UK Property, Aviva UK Property Trust, Henderson UK Property, Kames UK Property, M&G Property Portfolio, Standard Life UK Real Estate and Threadneedle UK Property.

Best performing UK property investment companies over the last five years

Investment company Market cap (£m) Annualised 5-yr performance * Dividend Yield Ongoing charges ** 

Premium/ (Discount) to NAV

Gearing
Picton Property Income 461.8 22.3% 3.9% 1.10% 6.3% 47%
Schroder Real Estate 337.0 20.1% 3.8% 2.50% 4.6% 41%
F&C UK Real Estate 247.9 15.8% 4.9% 1.67% 7.2% 42%
Standard Life Property Income 353.8 14.6% 5.2% 1.70% 13.9% 45%
F&C Commercial Property 1,167.1 12.8% 4.1% 1.18% 9.7% 29%

Source: Morningstar, The Association of Investment Companies, for the Property Direct – UK category
* Share price. ** Includes performance fee

Best performing UK property funds over the past five years

OEIC Fund size (£m) Annualised 5-yr performance  12-month Yield Ongoing charge
Legal & General UK Property Feeder Fund I (Dist) 1,685.8 7.2% 2.75% 0.75%
Legal & General UK Property I (Acc) 2,561.7 7.2% 2.51% 0.75%
Henderson UK Property PAIF Feeder I (Inc) 3,115.0 6.7% 2.93% 0.83%
Henderson UK Property PAIF I (Acc) Net 3,304.1 6.2% 2.90% 0.84%
Threadneedle UK Property Authorised GBP 2 1,185.0 5.9% 5.37% 0.81%

Source: Morningstar, for the Property – Direct UK category.
Where more than one class of fund features only the best performer is listed.

That flap, however, is a reminder that property is only suited to long-term investors and property funds particularly so, as the underlying asset (buildings) is not liquid (it cannot be bought or sold quickly).

Investors using funds must therefore be aware that when the next commercial property downturn comes – and it is a matter of ‘when’ rather than ‘if’ – they may not be able to exit gracefully or quickly at the price they desire.

Tracking the trackers

For those investors who feel that commercially property fits with their investment strategy, target returns, time horizon and appetite for risk, one further option to research is using a tracker (or exchange-traded) fund.

There are two options here: the iShares UK Property Exchange-Traded Fund (ETF), and the iShares MSCI Target UK Real Estate ETF.

The former is one of the 72 collectives which comprise AJ Bell’s Favourite funds list, the details of which can be found here.

It tracks the performance of an index of UK quoted REITs and at the time of writing its five biggest holdings are Land Securities, British Land, SEGRO, Hammerson and Derwent London.

The much younger (and much smaller) iShares MSCI Target UK Real Estate is designed to track and deliver the performance of a different underlying benchmark index and the portfolio is quite different. While the other product is 83% equity exposed with nothing in fixed income, this tracker’s assets are 59% in stocks and 34% in bonds, with the balance in cash and other options.

This final table compares and contrasts their performance of the past five years, as well as their fee structures and current dividend yields. It may be that the fixed-income element of the iShares MSCI Target UK Real Estate tracker appeals to more risk-averse portfolio builders and the iShares UK Property tracker to more aggressive investors.

Trackers offer another way to seek exposure to property, albeit via listed stocks or bonds rather than actual buildings

ETF Net assets (£m) Annualised 5-yr performance Dividend yield Total Expense Ratio (TER) Morningstar rating  Replication method
iShares UK Property ETF GBP (Dist) 822.1 13.2% 2.76% 0.40% n/a Physical
iShares MSCI Target UK Real Estate ETF GBP (Dist) (GBP) 9.9 n/a 1.82% 0.40% n/a Physical

Source: Morningstar, for Property Indirect - Other and Property Indirect - Europe categories
Where more than one class of fund features only the best performer is listed.

Russ Mould, AJ Bell Investment Director