As an asset class, property is known for delivering a steady and often generous income over time. The reason why the sector has historically been a fertile hunting ground for income seekers is that up to 85 per cent of a property’s return comes from the income component, according to Guy Glover, manager of the F&C UK Property fund.
But does property still look attractive compared with other income-generating assets?
“With the recent volatility in the markets and potential earnings being downgraded from some quoted companies – with gilts coming in as well – the case for property remains as strong as ever,” Mr Glover says.
“The nice thing about property is that it’s backed up by contracts. For example, a building is let on a 10-year lease and you know you’ll get your nice, long-term income from that contract rather than it being based on the earnings of a company which may fluctuate over time.”
He adds: “There’s growth to that income stream as well, and on a comparative basis it’s exceptionally attractive.”
Average income from property is between 5 and 6 per cent, with rental growth in the past 12 months of 4 per cent, Mr Glover notes.
London is now being used more as a capital store play for investors Colm LauderColm Lauder, vice-president at IPD property indices firm MSCI, says: “Government bond yields are at such lows they’re not going to attract anyone but the most risk-averse investors. Real estate sits out on its own as an asset class where pricing is still quite attractive, and in a comparative strength so is the income stream.”
But Mr Lauder believes the UK property market has become polarised in terms of the role of income versus capital. “We’ve seen a big shift particularly in London where income yields are at record low levels,” he says.
“So there’s an argument [that] London is now being used more as a capital store play for investors rather than an income element.”
Gillian Tiltman, manager for the UK and European portion of the Neuberger Berman Real Estate Securities group, concurs: “In the underlying property market in the UK, while we’re starting to see signs of rental growth, capital values and the yields that the properties are sitting on are hitting an all-time low.
“It depends on what your return requirement is. If you’re a Japanese investor sitting in Japan thinking interest rates are negative, then 3 per cent on a West End office property looks like a pretty good deal, but for us that’s looking really expensive.”
She adds that UK property is less compelling from the perspective of an income seeker. “We’ve been tilting more towards continental Europe and the US, which we think is a little bit more compelling.”
| EXPERT VIEW – UK property Income |
Stephen Hayes, head of property securities at First State Investments, reveals which parts of the UK property market are providing income: “Property market fundamentals continue to improve in the UK. The unemployment rate has declined, supporting occupancy rates. Rental demand in the London office market remains particularly strong and is outpacing that in other regions. “Vacancy rates in London are at low levels – below 4 per cent in the City and less than 3 per cent in the West End – and are expected to remain low given the lack of material new supply that is anticipated before 2018-19 at the earliest. “Rental growth for A-grade office buildings in both the City and the West End is in the double digits, supporting investments in companies such as British Land and Hammerson, which own privileged assets in the UK capital. “We believe we are only part of the way through an extended period of the market rental growth cycle in London.” |
Ms Tiltman says there is still a place in a long-term investor’s income portfolio for property. “A property investor should think about alternative forms of investment versus retail direct property funds, because I think they’d be better off investing in Reits [real estate investment trusts] which offer flexibility and liquidity compared to bricks and mortar.”
Stephen Hayes, head of property securities at First State Investments, offers a brief explanation of the Reit structure and its benefits. “Property securities are often structured as tax-efficient Reits, which pay no corporate tax from passive earnings and distribute most of their net profits, enabling them to pay high and stable dividends to investors,” he explains.
“Global property securities are attractive to investors for their potential to provide access to the stable income streams and property-type returns generated by high-quality commercial buildings.”
The prospect of a European Union referendum on June 23 is just one of the many headwinds facing property and other asset classes. But for some managers, the falling pound prompted by talk of a Brexit is an opportunity for foreign investors.
David Wise, manager of the Kames Property Income fund, notes: “London is still attractive and I think with the moves we’ve seen in the exchange rates we’re likely to see more overseas investments.
“Some of that overseas money had started to move on to other European markets, and I think with the fall in the pound we’re likely to see people reappraising the attractions of the UK because it’s probably 10 per cent cheaper than it was [a few] weeks ago.”
For those prepared to remain invested in property for the medium- to long-term, the sector is likely to remain a reliable source of income, regardless of short-term macroeconomic headwinds.
Ellie Duncan is deputy features editor at Investment Adviser
