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Switch out of buy-to-let
Buy-to-let has lost its appeal due to tax changes. Max King looks at the best real-estate investment trusts (Reits) to buy instead.
Changes to stamp duty, capital gains tax and the deductibility of mortgage interest from property income have significantly eroded the appeal of directly investing in property, such as in buy-to-let. Listed real-estate investment trusts (Reits) may be a more attractive option.
There are a few obvious differences between the two types of property investment. First, Reits offer fewer opportunities to invest in residential property than direct investment, but more in commercial property. Second, it is generally easier to diversify your portfolio by investing in a Reit, but you will obviously have less direct control over your investment. Finally, returns from Reits will be net of management fees, but you don't suffer the direct expenses or time incurred by direct ownership. So investors with established buy-to-let portfolios might prefer to stick to what they know, but recent or smaller investors might prefer to switch to easier, more liquid and more tax-efficient Reits.
When it comes to picking a fund, some listed Reits offer a high level of secure income, but limited potential for capital growth. Others offer plenty of growth potential, but little security of income. There are, however, a few Reits that seek to combine income with capital gains, making them a reasonable substitute for buy-to-let investing. F&C Commercial Property Trust (LSE: FCPT), launched in 2005, was one of the first to be established, and now has assets of £1.4bn. The shares trade at a 6.6% premium to their year-end net asset value (NAV), but this should drop to around 4% on the next results. Despite some ups and downs, the annualised gain in the last five years has been nearly 12%. In addition, there is a monthly dividend of 0.5p, for a yield of 4.1%.
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The trust's largest asset is the St Christopher's Place estate, just off London's Oxford Street, which provides a steady flow of opportunities to enhance the estate and increase income. The most recent has been the redevelopment of an old pub, the Pontefract Castle, at the north end of the site into restaurants and flats. Two-thirds of F&C's assets are outside London. These include two office units in Aberdeen, which looked less than brilliant in the oil-price slump of 2015, but are now looking much better.
About £310m of low-cost debt enhances returns, which have consistently been a little ahead of the benchmark IPD UK Property index. The bad news is that dividends are still not covered by recurring earnings, which means that the dividend has never been increased, and so some of the asset purchases have been biased to income rather than total return.
A good alternative is Secure Income Trust (LSE: SIR), launched by serial property entrepreneur Nick Leslau in mid-2014. The fund's initial focus was on capital growth, with a 75% gain in NAV up to the end of 2016, but it now offers a yield of more than 4%. The shares trade on a 6% premium to year-end NAV, but this should soon narrow. The £1.64bn portfolio comprises four leisure attractions, including Alton Towers and Thorpe Park, 20 private hospitals and 55 Travelodge hotels.
Although the trust operates in sectors that are not regarded as mainstream, Leslau believes the assets have longevity. The fund's returns have been enhanced by high gearing (the ratio of debt to equity), but this is coming down, and there is £92m of cash for further deals. Leslau is confident about generating compound growth of about 11% for years to come, helped by the potential to improve or add to the properties and restructure leases.
Higher debt levels should mean that Secure Income Trust is higher risk than the F&C Trust, but Leslau's team has more than £100m of its own money invested in it. Overall, both Reits are worth locking away for the long term.
In the news this week...
Fund manager Neil Woodford has had a mixed week. Recent figures show that Woodford's Patient Capital Trust saw a net asset value loss of 4.2% for the year to the end of 2016, compared with a gain of 16.8% for the FTSE All-Share over the same period. Indeed, the firm's long-awaited second income fund attracted only a third of the funding of its previous offering, suggesting investors had "reached saturation point' with the star manager's funds", says Aime Williams in the Financial Times.
And just last week, US biotech company Northwest Biotherapeutics, in which Woodford Investment Management has a $180m (£140m) stake, "warned that it may not survive without more cash", says William Turvill in City AM. Shares in the biotech company, which is developing a new brain cancer treatment, have fallen nearly 90% since October 2015, amid a wave of short-selling.
But on a more positive note, Woodford's investment firm received "a multi-million pound windfall" last week, after it was announced that MasterCard would trial a fingerprint-scanning technology using sensors designed by one of its holdings, says James Titcomb in The Daily Telegraph. Shares in Oslo-listed IDEX were up 18% by the week's end on the news, with Patient Capital Trust seeing its 26% share in the company increase in value by £62m to £100m.
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Max has an Economics degree from the University of Cambridge and is a chartered accountant. He worked at Investec Asset Management for 12 years, managing multi-asset funds investing in internally and externally managed funds, including investment trusts. This included a fund of investment trusts which grew to £120m+. Max has managed ten investment trusts (winning many awards) and sat on the boards of three trusts – two directorships are still active.
After 39 years in financial services, including 30 as a professional fund manager, Max took semi-retirement in 2017. Max has been a MoneyWeek columnist since 2016 writing about investment funds and more generally on markets online, plus occasional opinion pieces. He also writes for the Investment Trust Handbook each year and has contributed to The Daily Telegraph and other publications. See here for details of current investments held by Max.
