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.
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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.
