Fund selectors are considering an overhaul of property allocations to better play the next stage of the asset class’s investment cycle.
Real estate is poised for another year of double-digit returns, driven by both capital growth and income. But some suspect future performance will be based on income alone.
The Investment Property Forum predicts that capital growth across the sector will halve in 2016 to 4.1 per cent, before falling away altogether in the following three years.
Charles Hepworth, investment director in the multi-asset class solutions team at Gam, said domestic real estate valuations had peaked.
The manager is moving towards broader-based, income-orientated products as a result, specifically the Premier Pan European Property Share fund, which is a direct equity play on the sector.
Mr Hepworth said: “The market goes through predictable cycles and we are at the end of that. We are going more liquid, and property companies are high dividend payers.”
Harwood Multi Manager chief investment officer Richard Philbin thought the decision to focus on either capital or income was finely balanced, but acknowledged income was becoming a bigger priority.
“At this stage in the economic cycle it is about making properties work harder and making the income stream better,” he said.
Mr Philbin holds both open and closed-ended funds from F&C in a play for yield and diversification, alongside three other property trusts.
Custodian Capital managing director Richard Shepherd-Cross said the expected reduction in capital growth’s contribution to total returns could provide closed-ended portfolios – which typically have a greater income focus – with an opportunity to take market share.
Mr Shepherd-Cross added that yield compression seen across the sector recently was mainly a result of capital growth.
He said yields had compressed by 93 basis points from the third quarter of 2012 to the same period this year, though this was less the case for real estate trusts.
“We have seen three years of strong capital growth and you have to question whether some funds will get any more,” he said.
“We will see some switching to more income-orientated funds.”
According to Numis, the UK property investment trust peer group delivered a net asset value (NAV) return of 10.8 per cent to the end of September – mainly driven by capital growth, which accounted for 6.9 percentage points of performance on average. However, the broker said the sector was trading on an unweighted average premium of 2.4 per cent to historic reported NAV, down from 5.1 per cent at the end of September.
Furthermore, factoring in October figures from data provider IPD, Numis said the average premium to its estimated NAV was just 0.8 per cent, compared with the average of 6.1 per cent for the past year.
“We believe the prospect for near-term NAV total returns remains positive, underpinned by high income returns and value-enhancing asset management initiatives,” Numis added.
“We would expect the return characteristics of the sector to remain in demand and suggest that share price weakness could offer an attractive entry point for investors seeking income.”
But Vestra Wealth head of investment solutions Meena Lakshmanan said she began looking for a property fund last week but was undecided as to which type of portfolio to choose.
She said: “Investment trusts are trading at a premium and I am not paying [a premium]. The problem with open-ended funds is they will blow up and you have to time it right to make sure there is not a cash drag.”
