How to play a UK property rebound

Oxford Street © iStock
Property investors could do worse than go shopping in Britain

After three years of double-digit returns, 2016 has been dull for property investors. The IPD UK Monthly Property index, which tracks the perfomance of £45bn-worth of direct real estate investments, has returned under 1% year-to-date. Meanwhile, the listed property stocks, which dropped sharply after the Brexit vote, have recovered most of the ground they lost, but are still set to end the year lower. 

In reality, the UK property sector was struggling even before the vote. The rise in stamp duty had hit the high end of the residential market hard, especially in London, while retail property was under pressure from excess supply and the steady growth of online shopping. This all pointed to a dull period ahead, albeit not a significant downturn.

In contrast, European property markets have fared better as investor demand for income has pushed up values, while there has also been rental growth in some cities. UK-based investors in Europe have benefited from a drop in sterling, though this is now being reversed.

This divergence of performance between the UK and Europe makes TR Property Investment Trust (LSE: TRY) an ideal way to play the sector. Of the £1.2bn portfolio 92% is invested in property shares, with the remaining 8% directly in property. Marcus Phayre-Mudge, the manager, shrewdly started reducing UK exposure in 2015, so nearly 70% of the equity portfolio is in Europe. The result has been a rise of 7.7% in the trust’s net asset value (NAV) in the six months to 31 October, slightly ahead of the FTSE Epra/Nareit Developed Europe index.

Returns have been held back by a widening in the discount to NAV at which the shares trade (currently 13.5%), but better sentiment should see that reverse. Gearing of 12% should further enhance the trust’s performance in a rising market, as it has done in the past. The last five years have seen returns compound at 17.5% per annum, 4% ahead of its benchmark index. This makes the management fee of 0.5% of net assets good value, though there is a modest and well-deserved performance fee on top. Finally, a prospective dividend yield of nearly 3% is attractive.

Phayre-Mudge believes European property shares will continue to perform well, owing to demand growth and a lack of supply in many sectors. Sentiment is very negative in the UK, he says, but companies have been prudent in bringing down debt and cautious on new developments.

While he is not yet ready to raise UK exposure, the case for doing so is strong. The Autumn Statement projected only a mild economic slowdown in 2018-19 (and even that could prove too pessimistic), and the fall in sterling makes UK property an attractive investment for overseas buyers. Global rather than EU factors have propelled the growth of London in recent decades, which looks unlikely to change.

This reasoning could justify some direct investment in the specialist London companies in the TR portfolio. Shaftesbury (LSE: SHB) focuses on areas of the retail market that continues to do well, such as shopping and leisure “villages” in central London. Great Portland Estates (LSE: GPOR) develops and manages offices in central London, primarily in the West End, where supply is severely constrained, but also in the City.

Derwent London (LSE: DLN) refurbishes tired-looking office buildings, thereby adding lettable space and raising rentals, in off-prime locations. CLS (LSE: CLI) has prospered through its focus on the previously neglected “south of the river market”. If you have the time, consider going to look at some of the properties these firms own. There is no part of the stockmarket where direct research is more straightforward.

Merryn

Claim 12 issues of MoneyWeek (plus much more) for just £12!

Let MoneyWeek show you how to profit, whatever the outcome of the upcoming general election.

Start your no-obligation trial today and get up to speed on:

  • The latest shifts in the economy…
  • The ongoing Brexit negotiations…
  • The new tax rules…
  • Trump’s protectionist policies…

Plus lots more.

We’ll show you what it all means for your money.

Plus, the moment you begin your trial, we’ll rush you over THREE free investment reports:

‘How to escape the most hated tax in Britain’: Inheritance tax hits many unsuspecting families. Our report tells how to pass on up to £2m of your money to your family without the taxman getting a look in.

‘How to profit from a Trump presidency’: The election of Donald Trump was a watershed moment for the US economy. This report details the sectors our analysts think will boom from Trump’s premiership, and gives specific investments you can buy to profit.

‘Best shares to watch in 2017’: Includes the transcript from our roundtable panel of investment professionals – and 12 tips they’re currently tipping. The report also analyses key assets, including property, oil and the countries whose stock markets currently offer the most value.