Looking for income? Buy these three solid property funds

What looks like a bargain often turns out to be anything but. With interest rates and bond yields at rock-bottom levels in recent years, many investors have poured money into equities offering not just a high yield but also the prospect of capital gains. Widespread dividend cuts earlier this year tore these hopes apart, providing an expensive lesson that if it looks too good to be true, it probably is. High-yielding shares have hidden risks but there are exceptions, especially when, as now, investors are cautious.

Many funds in the property sector, for instance, weren’t getting the benefit of the doubt, yet the decision by ICG Longbow (LSE: LBOW) to commence an orderly wind-up, resulting in a 16% jump in the share price, shows that the market isn’t always right. The shares now yield 7% and trade at a 13% discount to net asset value (NAV), so they still look attractive.

Investing in property loans

UK Mortgages (LSE: UKML) also invests in property-backed loans so its income is not sensitive to the capital value of the underlying property, only to the credit-worthiness of the borrower and the security backing the loan. Launched in 2015, it is managed by Twentyfour Asset Management, a boutique firm specialising in fixed interest, and has £186m of net assets invested in residential mortgages. The portfolio consists of six pools containing £1.65bn of mortgages in total, a quarter owner-occupied, the rest buy-to-let.

MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

These pools were assembled by the lenders, such as Coventry Building Society, and then “securitised” with low-cost loans. The residual £172m (there is £14m of cash) provides UKML with a yield close to 10%, enabling it to target a total return of 7%-10% per annum after costs.

Clearly, the portfolio is highly leveraged but the average mortgage size is under £200,000, the average loan-to-value is below 70%, the average interest rate is 2.7% and less than 0.5% of the mortgages are three months or more in arrears. The number of payment holidays is falling and Nationwide has reported that house prices increased by 5% annually in September, the highest growth rate in four years. Despite this, the shares at 67p yield 6.7% and trade at a 16% discount to NAV. Yet a few months ago M&G, on behalf of one of its funds, bid 67p a share, a bid that was later increased to 70p.

M&G’s fixed-interest team is highly regarded so the bid was a powerful endorsement of the outlook for the portfolio and its rejection by UKML’s board implies that they agree. UKML also states that “fair value (ie, NAV of 80p a share) is not projected to represent a simple realisable value as the portfolios will be held to maturity”. The realisable value is stated at 95p a share so the shares still look cheap.

A Reit poised for growth

The shares of GCP Student Living (LSE: DIGS), a real estate investment trust (Reit), trade at a 17.5% discount to NAV. Management expects to receive only 62% of budgeted income this academic year compared with 82% in 2019-2020 and a five- year average of 94%. The structural shortage of student accommodation, especially in London, which accounts for 80% of DIGS’ assets, underpins long-term letting prospects but the short-term fall in income has led to the dividend being slashed. This year’s expected income after expenses should still be nearly double financing costs but that would only leave enough to cover a dividend of around 2p.

Restoration of the 6.2p dividend would imply a 4.4% yield and, perhaps, return the shares to the premium at which they traded before the pandemic. With mass vaccination just a few months away, the outlook for providers of student accommodation has brightened. The shares of DIGS still look attractive.