Commercial real estate investment trusts have two potential tailwinds — a perceived inflation link and post-pandemic recovery. Hopes that these would boost UK Commercial Property Reit’s net asset value made it one of the best-performing investment trusts in January and culminated in its shares hitting a near-two-year high last week.
Selling retail and office properties and tilting further towards industrial assets with higher-returning development potential meant that the FTSE 250 constituent generated a net asset value total return of 8.7 per cent during the final three months of last year alone, ahead of the 7.9 per cent return posted by the UK Balanced Funds Monthly Index.
Nevertheless, UKCM is not the inflation hedge that some investors might think — only roughly 25 per cent of leases have contractual increases that are either index-linked or fixed; the rest are open-market. Those increases also are capped at 3 per cent, with a floor of 1 per cent, yet inflation is set to rise above 7 per cent this spring.
What may be more interesting for investors is a heavy weighting towards industrial property, which accounted for almost two thirds of the portfolio value and just over half of the amount of rent due over the final three months of last year. In a sector where a steep imbalance in supply and demand has resulted in rapid growth in rents, the average rent for prime large and small and multi-let industrial properties rose by about 15.5 per cent year-on-year in January, according to Colliers International, the property services specialist. For UKCM, the expectation that such rental growth will continue pushed the value of its industrial assets up by just over a tenth during the fourth quarter of last year.
That could play well for income-seeking investors. Dividends have been gaining momentum and increased in the fourth-quarter payment to 0.75p a share, or almost 2.6p for the whole of last year. UKCM was among a wave of commercial Reits that cut payouts amid the onset of the pandemic, which meant the dividend was slashed to 2.3p a share in 2020 from 3.68p the year before.
At 3.1 per cent, the shares offer a lower yield than those of their peers, including pure-play industrial operators such as Warehouse Reit and Urban Logistics. The flipside? Shares in UKCM trade at an 18 per cent discount to NAV versus the premiums baked into both the aforementioned peers. According to Simon Elliott, Winterflood’s head of investment trust research, that discount reflects scepticism towards generalist commercial property Reits. Yet it also leaves more room to fill the vacuum between the share price and the trust’s NAV, which could be more appealing for investors wary of the premium valuations attached to industrial landlords.
Kerri Hunter, the interim lead manager, sees further scope for the 0.75p quarterly dividend to improve. Analysts at Peel Hunt reckon the fourth-quarter dividend implies that a payment of 3p a share could be on the cards for this year. That would equate to a more attractive 3.6 per cent dividend yield at the present share price.
UKCM is not immune to lagging demand for office space, which accounts for just over 14 per cent of its portfolio by value and 17 per cent of rent due. Rent collection for its offices was the weakest of any sector during the fourth quarter, at 93 per cent. Hunter sees the shortfall as “slower payment” and expects the rate to move back towards the norm of 98 per cent to 99 per cent. But the extent of the discount attached to UKCM means that the recovery could have further to run.
ADVICE Buy
WHY Gain exposure to high-growth industrial property while the shares trade at a considerable discount to NAV
The PRS Reit
House price growth might be slowing, but that doesn’t mean that affordability is getting any easier and that, in turn, should push demand for rented housing, a market already under-supplied, still higher.
It’s a dynamic that The PRS Reit is trying to tap into. The property trust acquires and funds the development of privately rented family houses and flats across England (but outside London) that it then lets on assured shorthold tenancies to individuals. The size of the portfolio has increased rapidly to 4,489 at the end of December, up from just over 3,000 a year previously. A rise in the estimated rental value boosted the Reit’s net asset value by 5 per cent to 104p a share, a penny above the stock market price, but Covid-related staff absences and disruption to its supply chain meant that a target to lift completed homes to 5,000 was pushed out from the mid-point to the end of this year. It eventually wants to expand the portfolio to 5,700 homes, with an estimated rental value of £55 million a year.
What comes after that? Options for increasing returns further include raising capital or selling completed assets to fund fresh developments, but for now the focus is on hitting its initial target and filling those properties. Leases come up for renewal every year, at which point rents typically are increased by 3 per cent to 4 per cent and are raised by between 6 per cent and 7 per cent for new tenants, which provides a source of underlying income growth for the Reit. Occupancy for homes completed stands at 98 per cent.
An undersupply in rental housing stock should feed through to further valuation growth, according to Jefferies, the investment bank. It forecasts a net asset value of 108p a share at the end of June this year, which would represent annual growth of 9 per cent.
Graham Barnet, founder of Sigma Capital, the Reit’s investment adviser, said that the company was happy with the present 4p-a-share dividend as a minimum, but analysts expect the annual payment to tick up to 4.22p a share next year, based upon the Reit hitting its 5,700-home target, which equates to a potential dividend yield of 4.1 per cent.
ADVICE Buy
WHY Good dividend yield at an undemanding valuation
