Property-based exchange-traded funds (ETFs) led the rebound from the March 2009 stockmarket low. But is the sector running out of steam? iShares’ FTSE EPRA/NAREIT UK Property Fund (LSE: IUKP) doubled in value within just six months of its post-crisis low (which it hit on 9 March 2009). But in the 15 months since then, its price has remained broadly unchanged. The only return investors have had is the income from the underlying property companies.
Rental income is, of course, a key attraction of this asset class. Most property ETFs track indices formed from real-estate investment trusts (Reits). These avoid corporation tax by agreeing to distribute at least 90% of income to investors.
The trouble with relying on that income stream is that it’s been falling dramatically. Reit yields are now back to where they were pre-crisis, with most now below 3%, having hit double-digit levels in early 2009. IUKP, which focuses on the UK Reit market, yields just over 3% now, from 9.7% last March (see chart).
Property ETF investors are relying on the continuation of near-zero official interest rates to justify current valuations. They’re also hoping government bond yields can be kept down through quantitative easing, as higher interest rates on bonds might start to move money from property (if yields on virtually risk-free bonds start to rise, investors will demand higher returns from an asset class such as property).
Looking through to the underlying rental portfolios, there are other grounds for concern. Many UK commercial property owners have an income cushion during the lifetime of a lease as a result of upwards-only rent reviews. But they’re not protected when leases are reset. In the City of London, for example, rents per square foot are down 30% from 1990 levels. Barring a sharp rise in demand from tenants, those 25-year leases contracted in 1990 are likely to be renegotiated at lower levels once they expire in 2014/2015, hitting investors’ income.
In the retail sector, Peel Holdings, owner of Manchester’s Trafford centre, says it has managed to avoid letting space to discount retailers at low rents. However, keeping rents high in so-called primary locations has just reinforced the divide with secondary commercial properties, which command much lower values.
So early 2011 seems a good time for investors to trim any holdings in property ETFs – or, if you’re an adventurous type, to consider a short sale.
• Paul Amery edits www.indexuniverse.eu