Hardeep Tawakley
As property continues to deliver for investors, value is becoming harder to find. Investment Week asks allocators and fund managers which sub-sectors still look like attractive propositions.
Oliver Harris, managing partner, Montreux Capital Management
Care homes
The care home sector, a relatively unknown but growing space, remains the preserve of a small band of investors. But it is now being increasingly recognised for its low correlation to other assets, its low volatility characteristics, as well as its high and sustainable level of income.
The care home sector’s emergence as an alternative form of property investment is underpinned by attractive and undisputable demographic trends, such as longevity and an ageing population. The provision of residential care is not subject to market forces and the payers for such services are not directly affected by short-term sentiment.
The sweet spot for investing in care is with the operating companies, which are both the providers of care and owners of the real estate. The leading operators are creating profit levels in the region of 25% to 28% for care provision, with gross fees being linked to RPI.
Such a solid level of return helps to provide a high and inflation proofed income stream for investors, which is currently producing a running yield in the region of 8%. While it is not on every investor’s radar, this sector is being increasingly recognised as a credible portfolio diversifier and can provide a solution in the continued quest for truly alternative assets and income.
Michael Morris, CEO, Picton Capital
UK regions
UK commercial property should deliver a double-digit return in 2015. While it may be lower than the 18% recorded in 2014, it is still respectable.
It is important to remember capital values remain 26% below their 2007 peak and not to be distracted from the regional sub-markets by the prime London market, especially when looking for value.
The UK market is recovering at different rates according to region and submarket. For example, central London retail has seen 68 months of positive capital growth, whereas regional shopping centres have recorded negative valuation movements for 45 months.
Rents in some regions have only just started to recover in the past 12 months, new supply has been constrained since the downturn, and rents in many regions remain below the level where it is economically viable to develop.
John Ventre, manager, Old Mutual Spectrum funds
Commercial
2013 and 2014 were both strong years for UK commercial property, and this momentum has continued into this year. Despite these gains, the asset class remains a value opportunity relative to other sources of portfolio diversification, such as fixed income and cash.
Commercial property is a momentum asset class – once it starts to rise then gains tend to continue. As most properties do not change hands in a given period, they must be valued with models rather than by the market, which can be much more fickle.
Interest rate rises could prove to be a bump in the road, but expectations for rate hikes in the UK continue to recede. Even from this perspective, there is a lot more margin of safety in commercial property than there is in fixed income, for example. Many commercial property funds still have high cash balances they are trying to invest and the asset class continues to receive strong inflows, reducing the risk of a rapid reversal.
Andrew Brunner, head of UK investment strategy, Morningstar
Slowdown begun
There is little doubt a slowdown in UK commercial property capital value growth is under way. The highest growth rate occurred between May and July last year at a 16% AR, compared to half that pace over the past three months.
While there are still overseas buyers of trophy assets, prime yields have stabilised close to pre-crisis levels. Certain areas are seeing some upward pressure on yields, but expectations are for only a modest firming in ‘prime’.
The shortage of available property and the weight of money will likely see investors attracted to higher quality secondary property in major regional cities. Alternative areas are also on the radar of many fund managers.
Tim Mockett, managing director, property, Impax Asset Management
‘Green’ alpha
Global transaction volumes scaled $710bn in 2014, with activity only exceeding this level at the peak of 2007. At these levels it is becoming more difficult to generate desired returns. Many investors are consequently exploring and allocating to specialist, value-adding strategies and we see a growing demand for sustainable property.
Sustainable buildings are commanding a rental premium, have shorter vacant periods, slower depreciation, reduced obsolescence, and command higher capital values. Most new buildings are constructed to high sustainability specifications but there is scope to create value for investors by adapting buildings from ‘brown to green’.
Green alpha is the premium that can be generated by successful investment in sustainable property – over and above the ‘normal’ market return.
Cesar Perez, global head of investment strategy, J.P. Morgan Private Bank
German real estate
European real estate markets are witnessing gradual improvement and have drawn interest from new geographies of investors. However, there are wide yield discrepancies in the market, depending on countries, sectors, and differentiated by prime and secondary areas. Prime location in London shows an expensive valuation and therefore I prefer second tier commercial real estate in the UK as yields are attractive.
Similarly, German real estate is a good way to access improving domestic consumption. Furthermore, yields have come down to mid-digits, both in private and commercial areas, and those levels look attractive compared with low bund yields.
With regards to the periphery, there are still distressed assets to be offloaded from the banks’ balance sheet. Italy’s potential is particularly interesting, as the prospects of creating a bad bank and the improving economy should foster an environment of gradual recovery for prices and yields.
James Carthew, research director, QuotedData
Retail Property
The attraction of the funds in the property sector is simple – their dividend yields. As evidence for this, the one UK property investment company that does not pay a dividend, LXB Retail, is trading at a discount. The sector is likely to stay popular as long as interest rates remain subdued and the current deflationary environment persists. It looks like that could be the case for some time. What is harder to predict is how strong the retail market is likely to be post the election.
If a new government does not take action that curbs retail spending, then LXB might be interesting, but a slump in retail could hit funds like F&C Commercial Property and UK Commercial Property too (they have around 40% of their portfolios invested in retail property).
If it is just yield that you are after, student accommodation specialist, Empiric Student Property, stands on the highest yield of the UK property investment companies and is more attractively priced than its competitor, GCP Student Living.
Hugo Machin, co-manager, Schroder Global Property Securities fund
Commercial
Real estate continues to offer an attractive investment proposition but investors will need to be selective. Supply is limited in many locations and new construction is being undertaken only on the back of space which has been pre-let. The low level of supply means those companies owning property in the more desirable locations are seeing not just capital appreciation, but rental growth too.
Broadly, demand is firming as a lack of supply and signs of economic growth underpin commitments to new space available for rent. There is appetite for commercial real estate from sovereign wealth funds.
If, as we suspect, economic growth and business sentiment is improving, companies will look to expand in the major global cities as businesses seek to keep pace with their global customer base. The best assets in undersupplied markets will continue to grow rents faster than their competitors and this should provide a buffer with respect to increasing bond yields.
Philip Saunders, co-manager, Investec Diversified Growth fund
REITs
Although commercial property assets in the UK and Europe are expensive by past comparison, they are still in the process of being re-rated to reflect the changes in the secular interest rate environment. This is likely to be characterised by deflation and persistently low real and nominal interest rates. Markets have consistently underestimated the benefits to property company revenues accruing from being able to re-finance at lower rates.
We have been investing in property primarily through REITs for a number of years, believing they can provide attractive growth and income. We strongly believe, however, that property is not a homogenous or fungible asset class, with regional and sector dynamics significantly impacting the outcomes facing investors. Our UK property exposure, therefore, has been focused on central London commercial property given elevated demand, limited supply, and solid rental growth, with our preference for those management teams who have strong records in adding value to their portfolios.
Stephen Allen, senior investment manager, Architas
Student accommodation
One area of property to consider at the moment is the specialist area of student accommodation. The arguments for the asset class seem to make sense right now as the UK’s higher education system is well regarded and seeing increasing student numbers, many from overseas. These students are looking for quality, modern, purpose-built student accommodation which remains in short supply, particularly in London.
There are early signs of increasing rents in this sector for the next academic year, and the overall market dynamics of strong demand, high occupancy and a potentially attractive yield ought to offer some further potential capital appreciation and income growth in our view.
We are currently invested in this area via closed-ended investment trusts such as GCP Student Living. This niche asset class lends itself to a closed-ended capital structure where it is not subject to the liquidity demands that can force similar open-ended funds to hold larger cash allocations, which ultimately drag on returns in a rising market.
Anne Breen, head of real estate research and strategy, Standard Life Investments
Global office markets
Prime assets in the best locations are becoming fully priced in the context of the moderate growth outlook. Core-style funds will continue to source opportunities in these locations, but we believe there is better value in assets requiring a certain level of asset management to return them to an investment grade standard. Opportunities in this corner of the market are more abundant, with many assets having been underfunded during the last six years and underlying economies expected to grow during 2015 and into 2016.
Geographically, risk-adjusted returns will remain attractive in the UK and continental Europe in the context of low bond yields. We expect the largest and most liquid global office markets, including New York, Los Angeles, Sydney and Tokyo to return between 9% and 10% on average over the next three years. Closer to home, prime major city high street shops in the UK are expected to perform well, driven by yield compression and more buoyant consumers.
Dominic Field, chief executive officer, Temple Field Property
Battersea & Nine Elms
When an asset class has experienced a significant run up in value there will invariably be a concern what value remains for newer investors. London residential property is a case in point; some London boroughs having seen capital values rise by more than half in just five years. We would contend, for three specific reasons, that there remains value.
Firstly there is, and will remain, a chronic imbalance between supply and demand. In addition, the massive investment in infrastructure, and in planning, means London will continue to attract international businesses – which can access workforce from further afield. Finally, London’s increasing prosperity is feeding through into wage growth; that is increasing rents, which in a low interest rate environment is attracting investors, and that will push up prices.
We see locations proximate to major redevelopment growing most in value in the medium and longer term, high yielding ex local authority property in the Battersea/Nine Elms region is a good example.
Simon Cooke, founder, APAM
Secondary stock
A considerable amount of regional secondary stock has been poorly managed over the last eight years as borrowers defaulted on loans and lenders had to firefight in a weakening market. Many of these assets have been traded wholesale to large private equity investors and as tenant demand begins to emerge, kick-starting a return of rental growth, adding value at the asset level is the real opportunity rather than simply waiting for further yield compression.
Generally high street retail has been overdone by valuers and should see a positive correction over the next few years, as the consumer returns to the high street and confidence grows.
Avoiding assets where yield shift is the only driver of performance has always been the soundest investment strategy. Identifying pockets of rental growth, neglected and undermanaged assets in areas where tenant demand is strengthening or implementing change of use will prevail when looking at current pricing. While investors and experienced operating partners can identify these assets, value will continue to be found.