Every investor should pop some property in their portfolio. Reits are the way to do it, says David C Stevenson.
Most private investors don’t have time to constantly monitor the markets. They want a quality asset, paying a steady dividend, with an opportunity for capital growth, and some protection against potential future inflation – as well as some balance sheet protection against deflation!
Equities generally tick most of these boxes – but real estate investment trusts (Reits), in particular, should be part of any long-term portfolio. They’re not without risk – they are shares and so are volatile – but they have delivered impressive returns over the last few decades and my hunch is that they’ll continue to benefit the defensive investor in the decades ahead.
Here comes the super-Reit
But which fund or Reit should you buy? I’ve previous suggested a mini-portfolio of income-generating Reits and infrastructure funds. But is there a fund that does all the hard work for you? One such ‘super-Reit’ is TR Property (LSE: TRY), managed by Thames River (now part of F&C).
I’ve invested in this, on and off, for most of the past decade and it’s been a ‘no-brainer’ – it simply offers the most robust property developers and Reits via one London-listed fund. Net asset value (NAV) returns over the last ten years have been 172%, and 70% over the last five.
The average UK-specific Reit has delivered 71% over the last five years. At £815m in market value, yielding 2.9% and with a discount of 2% against NAV, TR Property is an elegant solution for your portfolio – just let its fund managers track the commercial real estate sector for you.
But ideally I’d like an alternative, perhaps more global in nature, that pays a slightly lower yield (in return for more capital growth potential) and trades at a chunkier discount. That’s what may be on offer at Investors in Global Real Estate (LSE: IGRE) – soon to be renamed Schroder Global Real Estate Securities.
This investment trust has a decent short-to-medium-term record, but hasn’t shot the lights out. So Schroders, under its head of property Duncan Owen, has been called in to shake things up.
Two big changes are on the way. The first is that hopefully the mandate will be changed after an Extraordinary General Meeting this month. According to Numis analysts, the old objective was to target a decent total return by “investing in listed global real estate securities… selected primarily for their potential to provide high and rising dividend income leading to long-term capital appreciation”.
If Schroders gets its way, that’ll change to “an attractive total return, through investing in listed global real estate securities which the company’s investment manager believes have strong fundamentals, offering sustainable income and progressive dividend potential”.
The key words are ‘strong fundamentals’. Put simply, the old mandate’s focus on income could have resulted in a bias towards higher-yielding investments with weaker balance sheets. The new managers want more quality real estate funds, where the balance sheet is strong and there is a chance for good long-term capital growth.
This matters. You can use Reits as a surrogate for bonds, but really you should be neutral as to whether your returns come from income or capital gains – you should only be concerned with total returns. So if the income yield is lower, but the potential for capital gains higher, so be it!
This may result in a drop in the dividend yield to around 1.4% if the mandate changes, but I think that’s the right focus. Too many investors have chased high yields from businesses with poor balance sheets – better now to put your money to work on more cautious funds where the bigger potential is from capital gains over the next few decades.
I also think there could be upside from this shift towards ‘quality’ – in the form of a re-rating of the shares. Schroders’ other big Reit trades at a premium of 2% to NAV, but this fund is currently at a 10% discount or so, and I suspect some investors may sell the fund because of the falling dividend.
But eventually, Schroders’ ability to raise more money and to sell the trust down their own substantial customer lines could see that discount narrow appreciably. Perhaps most importantly, you still get global access to the whole Reit sector via one small fund, run by a highly regarded team.
Investing in students
Another opportunity has popped up on my radar in recent weeks – student property. I’ve long been a fan of this sector. Our world-class university sector needs high-quality student housing, but more broadly, there’s a growing need for ever more professionally run serviced accommodation in UK society.
Be it for students, lower to middle-income families or older, retired people, there’s insatiable demand for high-quality serviced accommodation – people will happily pay a premium for this as long as it meets the right standard.
The key with a student accommodation fund is to raise capital at a sensible price, get a developer to do all the risky stuff, then sit tight and watch the inflation-adjusted income come in. It’ll never set the world alight, but it has the potential to deliver 5%-7% annual total returns over the long run. I think there may also be a short-term opportunity here.
Put simply, our immigration rules are too tight for foreign students, regardless of what you may read in the papers. I suspect that most people in policy and government circles want to liberalise the rules to allow more foreign students to spend money at our universities, and in our wider economy. Any change in that direction would help student accommodation suppliers.
The problem until now has been accessing the sector – it has either meant investing in the excellent Unite Group, which builds and services this sector, or using one of the small number of specialist property funds.
Cue Empiric Student Property (LSE: ESP). It’s the only dedicated student property Reit in the UK – it listed on the London Stock Exchange in June and has bought or committed to fund 11 properties for around £85m.
After a recent deal in my home city of Southampton, it is now nearly fully invested and is due to update the market any day. The long-term aim is to grow the portfolio, with a target of 8,000-10,000 beds (currently 1,058).
The classic property is a self-contained studio flat, with a small number of two-bed apartments, plus bike storage and other communal facilities. Properties are in all the usual red brick places like Bristol, Exeter, Cardiff, Edinburgh, Birmingham, Aberdeen, Nottingham and of course Southampton, with its 200-plus rooms.
The fund is run by a team drawn from specialists at London Cornwall Property Partners and aims to pay inflation-linked dividends of about 1.5p per quarter by 2015, with 7% average annual growth in net asset value. Another candidate for my mini portfolio of infrastructure and real estate funds.