Wednesday, 24 February 2021

Property The REIT Way

In search of asset diversification, property has its attractions. Without the risks and hassle of owning property directly (surely one home is enough trouble?). 

But how has COVID and BREXIT affected the UK commercial property market? And what are the options for using the property asset class to derive income in your portfolio?
It's fair to say that you would need a strong stomach to invest in the commercial property market at the present time. Still, as Warren Buffett always says: “be fearful when others are greedy, and greedy when others are fearful”.

There is no doubt that events are weighing on the property market:
  • growth in on-line shopping and the steady decline of High Street, especially large-format stores
  • exodus of financial services as a result of BREXIT
  • impacts on city centres of COVID, including loss of business due to more working from home

There is a debate whether investing in commercial property is still a viable option and whether it can be relied upon for income in the same way as before, given these changes.

But if you remain bold, there seem to be three main ways to tap into the UK property market for income - apart from direct ownership: a REIT, a property-oriented investment trust, or a property-oriented ETF.

Real Estate Investment Trusts (REITs)

Most property companies are structured as REITs, a format introduced in the UK in 2007 (based on the US model) with the aim of improving overall investor access to real estate.  The biggest difference between a REIT and other companies is what they do with the rental income. According to the UK government REIT rules and LSE notes:

  • 90% of property rental business must be paid to shareholders each year  
  • 75% of the company's profits must derive from property rental business
  • 75% of the company's gross assets must comprise assets or cash involved in the property rental business.

REITs are exempt from corporate taxation on profits from property rental income and capital gains on the sale of investment properties. The consequence of this is to make the tax implications of investing in REITs similar to that of investing directly in property. For you, this means a steady income stream through a variety of market conditions. 

One thing to watch closely with such companies is the premium or discount to Net Asset Value (NAV). Every financial quarter, managers will tot up the value of all the assets a REIT owns. NAV equals the market value of a REIT’s total assets (mostly property, plus any cash it has) minus the value of its liabilities, such as mortgage payments and other debts.

Most UK REITs buy up and rent out commercial and office property. They get tenants on long leases, which gives them strong visibility on future earnings. But picking the right REIT is a matter of thinking clearly about the sectors that will benefit from wider market conditions. As discussed above, retail REITs that own shopping centres are a big no-no at the moment, for example. 

But safer segments of the REIT landscape may those involved in logistics, office space or healthcare.

Property Funds and Investment Trusts 

Funds and investment trusts are often seen as a better vehicle for less liquid assets like property, which are harder to buy and sell in short order, because they are listed on the stock market and the fund managers don’t have to factor in redemptions to how they invest. However, they will carry expensive on-going charges as well as trading at a discount to net asset value at times of stress.

An example is FTSE 250 investment trust BMO Commercial Property Trust Ltd (BCPT) - current yield over 8% (!) and trading at a huge 40% discount to its supposed value. It is fairly expensive to hold, with an on-going charge of 1.2%, which will pare down your returns. The trust had to stop payments for a period amid the height of the pandemic. Dividends restarted in August at the lower rate of 0.25p per month and they’ve been paid every month since. Importantly, dividends are now starting to go up – rising 40% in December to 0.35p. Although uncertainty remains regarding the impact of continued lockdown restrictions on the trust’s portfolio and tenants, it expects to continue paying dividends at this rate for the foreseeable future.

BMO's investment approach is set out on their website and includes a degree of borrowing.

Retail REITs

British Land (BLND), one of Europe's largest REITs, has a dividend yield of around 3.2% and a p/e of under 15. Its portfolio is split roughly equally between retail sites on one side of the equation and offices and residential sites on the other. 

Newriver REIT (NRR)  a predominantly retail property owner should perhaps be avoided, despite its current over 15% yield.

Commercial REITs

SEGRO (SGRO) is a British property investment and development company, formerly known as Slough Estates Group, which switched to REIT status. SEGRO develops and invests in property located in the UK and Continental Europe focusing on edge-of-town flexible business space.  It has a current dividend yield of around 2.3% and a p/e of 7.7. 

Logistics REITs

Tritax Big Box REIT PLC (BBOX) is a leading real estate company and FTSE 250 constituent that focuses on logistics real estate. It owns and manages sophisticated warehouses and lets these out to major retailers such as Amazon, Tesco, and DHL. Its yield is currently around 8% but with a high p/e ratio of around 28 (!). BBOX has built up an impressive track record in recent years. For example, it has now put together five consecutive dividend increases. The REIT is well placed to benefit from the ongoing shift to online shopping. As we do more of our shopping online, retailers are going to need more access to the kind of strategically-located distribution warehouses that Tritax owns.

Warehouse REIT (WHR) with a near 5% yield is another popular choice and its share price has rocketed back to pre-crash levels. But a price tag of over 19 times earnings may be a little steep for some.

Urban Logistics REIT (SHED) reported a near-doubling of its profits in 2019  from £9.8m to £18.7m. And 2020 year-end results on 29 May showed a 20% hike in rental income and a 21% jump in earnings. It also has significant financial firepower. In April bosses snapped up seven distribution centres for £47m in centres including Aberdeen and Plymouth and added a £13m West Yorkshire NHS distribution centre to its portfolio. Forecast yield is now only 2.5% at a relatively expensive p/e of 19 plus. 

Office REITs

Strong decision-making by the AEW UK REIT (AEWU) saw its after-tax profits soar 60% in 2019 to hit £15.5m. Its main investments are 35 diversified commercial properties across the UK, mostly outside the flagging London market. It offers a massive yield of 9.8% with a discount to NAV of around 14%; however, the ongoing charge is a hefty 1.3%.

Office and studio space provider Workspace Group plc (LSE: WKP) has an impressive 4.7% yield with a quite reasonable p/e ratio of 16. Over the last five years, the company has increased its dividends at an annualised rate of over 25%. This suggests that as well as offering an impressive income return and good value for money today, the company could also offer a rising share price as investor demand increases for a stock that has consistently-high dividend growth.

Another popular UK REIT is Land Securities Group plc (LAND) which owns and operates, among other properties, the ‘Walkie Talkie’ building at 20 Fenchurch Street in the heart of the City of London, as well as commercial spaces across the UK. It currently yields around 3.5% with a p/e of just over 11. 

West End-focused REIT Shaftesbury (SHB) - yield 2.7% but a massive p/e ratio of over 65 (!). With Shaftesbury currently trading on a price-to-book (P/B) ratio of 0.8, it seems to offer a wide margin of safety. When combined with its resilience to economic uncertainty and its capacity to raise dividends, this could mean that it offers an impressive total return over the long run that makes it more attractive than investing in buy-to-let.

Healthcare REITs

Target Healthcare REIT (THRL) offers a dividend yield of 5.9% and is trading at a premium of 5.5% to NAV. 

Care home investors like Impact Healthcare REIT (IHRpresent a long-term high-yield choice. This one pays out a 5.8% yield at a premium to NAV of around 2.5%. The ongoing charge is 1.6%.

Primary Health Properties plc (PHP) is a FTSE 250-listed REIT that focuses on healthcare facilities. Its portfolio comprises roughly 500 healthcare facilities across the UK and Ireland, the vast majority of which are GP surgeries. The REIT has a dividend yield of nearly 4% but a big p/e ratio of over 25 (!). However, the company is well placed to benefit from the UK’s ageing population and a large proportion of its rental income is backed by the UK government. 

UK Property ETFs 

The main advantage of ETFs are that they (usually) replicate an index passively, which provides both diversification and low cost. However, the downside is lower returns. 

For example iShares II plc FTSE EPRA/NAREIT UK Property Fund (IUKP) has a current yield of only around 2%, although it's on-going charge is relatively low at only 0.40%. 

Conclusions

So, as always, the decision comes down to the greed/fear calculation:

  • For big dividend yields, there are a couple of gambles available for the risk-taker, like AEW REIT, RDI REIT and  Newriver REIT
  • Medium-level returns seem to be available from several REITs in the office and logistics segments, with Workspace Group looking attractive
  • If you would sleep better at night, a property ETF will hopefully keep you ahead of inflation with some capital growth


Finally, a word of warning. I've held RDI REIT plc (RDI) which is pretty diversified, since 2014 but it's only worth half the price I paid for it. I guess I took my eye off the ball. At the moment it appears to pay a whacking 10.9% dividend with a p/e ratio of over 17,, so I guess I'll hold on. In fact, RDI had a major South African shareholder who now decided to exit the UK market. I don't blame him.
UPDATE 26/2/21 - Starwood is buying our the shares of RDI REIT for £121.40 - reducing my loss to a third.


I am not a financial adviser and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.

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