We live in extraordinary times for income-orientated investors. Finally, everyone seems to have come round to the idea that we’re going to be stuck in a low-interest-rate environment for longer than we thought – possibly decades. That means there’s a ferocious scramble for yield and quality stuff gets snapped up.
Not surprisingly, investment trusts are stepping up to the mark to meet this demand. Some of the funds being marketed at the moment look a bit too complicated for my liking, but others offer a stream of income payments that makes sense. As an investor, what you’re looking for is the kind of asset-backed, secure income stream that would traditionally be in demand from pension funds. Step forward a new real-estate investment trust (Reit) called Supermarket Income Reit, which looks like it might tick some of the boxes.
You guessed it: this Reit is buying up supermarket sites and will let them back on long, inflation-linked leases. Supermarket Income aims to raise £200m in an IPO this month to buy a portfolio of large grocery supermarkets with an average yield of around 4.9%. These tenants include the big chains – Tesco, Sainsbury, Morrisons, Asda – on long-term leases of 15 years or more. Such firms are, by and large, good-quality credit risks. This means banks are willing to lend against the portfolio of assets, with the fund aiming for a loan-to-value ratio of 40%. I’d estimate its interest rates will be around 2%. Once you add in this boost from gearing and then subtract the manager’s fees, you should be able to get a yield of 5.5%. There might also be the opportunity to increase capital values by adding smaller units or putting residential units on top.
The fund will be managed by investment company Atrato Capital, which has executed more than £3.5bn of supermarket sale-and-leasebacks over the past ten years, according to investment house Numis. Fees will be 0.95% of net asset value (less any uninvested cash) up to £500m, 0.75% up to £1bn, 0.65% up to £1.5bn and 0.45% thereafter. A quarter of the management fees will be paid in shares, and there is no performance fee. The fully independent directors and investment manager intend to invest £1.3m in the issue.
Overall, I’d say this new fund is a fairly boring idea that warrants closer inspection, especially for those seeking a yield of 5% or more per year. These are high-quality tenants, with long leases and good balance sheets.
There are two obvious risks here. Firstly, over the long term, these big retail boxes on the outskirts of towns might fall decisively out of favour, especially as energy infrastructure and planning rules change. The US is already seeing the increasingly rapid decline of big shopping malls in the wrong places. These big structural shifts could cause major problems for a supermarket portfolio. Add to the mix the impending arrival of Amazon, which has just announced a takeover of US chain Whole Foods, and you could see a big structural decline. That said, one of the positives of investing in supermarkets is that the buildings should have alternative uses if demand dries up.
The other obvious risk is that borrowing is a core driver of total investment return. This is par for the course in property, but these kind of funds are locking low rates into financial structures to drive up returns. That’s fine as long as interest rates stay low – which I think they will for a very long time – but the dangers are clear if rates rise.