100 Club: Rental growth set to provide stable returns

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100 Club: Rental growth set to provide stable returns

Investors should not expect a rerun of property’s stellar capital returns of last year, Standard Life Investments’ Jason Baggaley says.

The manager of the group’s £304m Property Income Trust said capital returns in 2014 were 12 per cent – the highest since 1993 – meaning such a number was “unlikely to be repeated for some time”.

However, Mr Baggaley said the income component of property investment – that which comes from tenants’ rent – would provide a stable platform for returns.

In the past year, the trust has maintained the strong performance that led to it entering the Investment Adviser 100 Club of top-performing funds.

The trust’s share price total return of 19.2 per cent in the past year eclipses the 7.3 per cent rise in the vehicle’s benchmark, the FTSE All-Share index, data from FE Analytics shows.

The prediction for returns by the manager was 7.1 per cent per annum for the next three years, with “the majority of this coming from income”.

Mr Baggaley said one tailwind for the UK property sector compared with its global peers was the fact it operated an “upward-only rent review”.

“This type of review means that the income will not drop during the duration of the lease,” he said.

“The income is relatively secure as, unlike dividends, the tenant has a legal obligation to pay the rent under its lease contract.”

The manager said the average income yield for UK commercial real estate was roughly 5.5 per cent, according to property index provider IPD.

Mr Baggaley said this level was in the “middle ground” of the 4 per cent level of “annuity-style” investments, such as long-let supermarket sites and the 9 per cent available with properties that tended to be “poor quality”.

He said rental growth was now picking up since there had been a “very limited supply” of good-quality accommodation in most markets.

“There has been virtually no new speculative development in the past eight years, albeit it has picked up modestly of late,” he said.

“The market is now seeing rental growth again and this is likely to continue for the next few years.”

At the end of the first quarter, Mr Baggaley said the occupation rate of properties owned by the trust was 97.5 per cent, with solicitors working on two further lettings.

He also said the average length of leases on properties in the portfolio had been extended to 7.1 years, which gave the trust better visibility of returns.

“Properties without tenants obviously don’t provide an income, so fund managers in the sector look to minimise voids,” he said.

“The sector void rate compares favourably with the overall benchmark index void rate. The benefit of having good-quality buildings in locations that tenants want to be, is that buildings can be purchased at an attractive yield and are let on shorter leases.”