Property regains favour as demand for income continues

Positive returns
The increasing attraction of property for investors can be seen in the discount movement from 32% at the end of September 2008 to 6.5% at the end of September 2011 for the Property Direct – UK sector. Income is a strong pull for this sector with yields currently averaging 6.3% but returns have been positive too, up 23% over the last three years to the end of September 2011 compared to the average investment company increase of 18%.

Jason Baggaley, Manager, Standard Life Investments Property Income, said: "Despite heightened volatility and unprecedented uncertainty resulting from the ongoing euro zone problems, UK Commercial Real Estate continues to be one of the few asset classes to provide reasonable positive returns over the year to date (according to IPD)."

Richard Kirby, Manager, F&C Commercial Property Trust said: "The property market has proved remarkably resilient in the face of slow domestic economic growth, fiscal austerity, a stalling of economic recovery overseas and the Eurozone crisis. There has been two years of sustained growth following a severe downturn. The initial sharp bounce-back, has been replaced by a year when performance has been largely driven by income. In September 2011, the annual total return was 8.7%, of which 6.9% was attributable to income, according to the IPD Monthly Index."

Stock selection
In the UK property market, London continues to outperform other regions although this difference could become less marked. Kirby said: "London has out-performed the regions, helped by a stronger local economy, a more affluent population, tight new supply, its role as an international as well as a national centre and its relative resilience to public sector cutbacks. Overseas investors have been attracted to this market, with London seen as a large, mature, transparent and liquid market. This out-performance is expected to persist for the next year or so but the gap between London and the regions may narrow, particularly for City offices, given the turmoil in the financial and debt markets. Nor should prime property in regional markets be written off."

Although the long term outlook for property is positive, investors must be prepared to weather any storms which may result from recent volatility. Baggaley said: "Some weakness in pricing is anticipated over the next few months as more stock is brought to market and it is likely that the softer prices are accentuated for secondary assets in poorer locations with greater investor demand continuing for relatively low risk assets. Despite some softening in the prices for poorer quality stock, reasonable positive total returns are expected over the next few years for investors as yields compensate for any modest capital declines."

A reliable source of income
Higher personal taxation and reduced pension contributions as well as an all-time low interest rate have contributed to the growing importance of income to private investors. Managers recognise the need to protect income streams and emphasise the importance of careful asset allocation in a poor macro-economic environment.

Baggaley said: "In the current environment, with a relatively weak economic backdrop, ensuring the quality and sustainability of income is a key investment decision-making criterion. Investors remain risk averse because of the economic volatility and are shunning poorer quality secondary and tertiary stock at present. However, these conditions may provide ideal stock picking opportunities for savvy investors where good value assets can be identified in relatively resilient areas and can be repositioned further up the quality spectrum.  We expect asset management initiatives and locational choices to be the defining characteristics contributing to income returns into 2012. Currently, for multi-asset investors, real estate assets that are located in relatively robust locations with reasonably financially secure firms as tenants are likely to continue to produce a compelling positive sustainable income yield that compares favourably with the depressed yield on a range of other "defensive" type assets."

Kirby said: "The coming year is expected to be more difficult given the economic backdrop and the downside risk implicit in the euro zone crisis. There are positive elements. Low interest and borrowing rates coupled with a second round of quantitative easing may offer support. The UK may be seen as a safe haven from the troubles of the euro zone. Looking to the longer-term, years of low development have led to areas of tight supply where a turnaround could be quick once demand recovers. For now though, the focus needs to be on the protection of the income stream and securing its longevity. There are differences within the market and this will involve selecting and managing property at the asset specific level."

Annabel Brodie-Smith, Communications Director, Association of Investment Companies, said: "Property is regaining its place as a mainstay of a well-diversified portfolio. The closed ended structure of investment companies is particularly suitable for this type of illiquid asset and the majority of the sector has bounced back following the property bubble of 2008/9. Property is once more in demand for its ability to provide investors with attractive levels of income."

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