Return to investing in real estate

Each week, a professional investor tells MoneyWeek where she’d put her money now. This week: Delyth Richards, head of funds research, Kleinwort Benson.

The property sector was hit particularly hard during the financial crisis of 2007/2008. British commercial property values saw their biggest correction between 2007 and 2009, falling 44% from peak to trough.

We now believe that an inflection point has been reached. The pace of monthly capital decline has slowed and there are signs emerging of capital growth. Investment Property Databank (IPD) data for May recorded the first price increase since November 2011. Although we have already seen a rally in real-estate stocks, British commercial property values have suffered a ‘double dip’ in real terms (adjusted for inflation), falling 5% after initially recovering by 18%. Prices remain 37% below the 2007 peak. We believe that there is now an opportunity to re-enter the market.

British commercial property provides investors with an attractive income return (a gross initial yield of 6.33%, according to the IPD). The asset class offers a substantial premium over government bonds, alongside values that are still substantially below the market peak.

While economic confidence overall remains low, there are encouraging signs of improving trends across the various property markets in the United Kingdom. We do not have the overhang of vacant properties that was seen during the last market downturn. Tenant demand and rental growth is evident in selective regional sub-markets. A wider audience is once again able to access finance. These positive signs suggest there is potential for further capital growth in the sector and, positioned correctly, this can go hand in hand with increased demand from investors.

British leases are typically reviewed every five years on an upwards-only basis. This means that rents are reviewed to market level, or – if this is lower than the current rent received – the rental income remains the same. The upwards-only nature of the leases and the net income received make the asset class attractive to institutional investors, who often consider real-estate income as similar to that generated by a bond. This steady rise in commercial rents is encouraging in the medium term, as investors can benefit from the overall confidence in the sector. This increased investor demand may also lead to an overall increase in capital growth.

British construction levels have hovered around January 2010 levels, showing sustained performance. In the residential sector, recent encouraging signs from major British house builders, such as Berkeley Group (LSE: BKG) and Persimmon (LSE: PSN), have shown that demand for new-builds is rising, in part helped by the government’s ‘Help to Buy’ and ‘Funding for Lending’ schemes.

We favour broad diversified commercial UK real estate, reaping the overall rewards from the sector as a whole, with a particular focus on the commercial real-estate sub-sector. Real-estate investment trusts (Reits) continue to offer opportunity for growth. UK property unit trusts, such as Henderson UK Property (www.henderson.com), also provide a sustainable income, with potential for growth. We think it is sensible to hold real estate as part of an overall diversified portfolio.