Is it boom time for property?

Ken Rayner, investment director of Rayner Spencer Mills, discusses the outlook for the property sector and identifies six star performers.

There are different types of property fund, as shown by the IMA definitions below. The first definition describes a direct property fund (one that. invests into actual buildings, or ‘bricks and mortar’), the second is a property securities fund (buys shares in companies that invest into property) and the third is a hybrid fund (a combination of the two).

The addition of property into a portfolio has traditionally been seen as a way to diversify real assets or invest in an asset that has a lower correlation to equities and bonds. Property also provides a good income yield whether capital values are increasing or not.

One important issue with property investment is that of liquidity. While property funds are clearly more liquid than directly holding property, they can still be a relatively illiquid asset. This caused particular concern during 2007/2008 when a number of funds could not sell properties to generate cash flow when they needed to and had to suspend trading in their funds. This meant clients could not access their money immediately, which caused problems for some investors.

Macro picture

Property funds have been affected by the economic downturn that hit most Western economies. The financial crisis was primarily brought about by the boom and then downturn in the residential property market, as banks increased their lending and consumers took on more debt. However, the commercial property market was also affected, as the same banks were also lending to commercial property buyers.

Many assets correlated downwards during this time and it demonstrated that there are few safe havens in times of extreme economic stress. Growth in the UK and eurozone currently faces the headwind of the authorities tightening their fiscal belts. In particular, concerns over solvency in the peripheral European nations are likely 
to persist.

From a valuation perspective, the property sectors in the UK and Europe appear broadly fair value relative to other assets, although in the UK property yields, in real terms, are looking less attractive, as CPI has continued to surprise on the upside. There is difficulty in finding good value outside of primary property with little demand in the secondary sector outside of the south east and London.

Picking a winner

When choosing funds in this area, we differentiate between direct property, which we would see as more of a core holding, and property security funds, which we would see as satellite holdings. Direct property funds are the more traditional property investment, but property securities funds bring international exposure. These funds are more volatile, but also more liquid than traditional direct property funds and provide diversification to a typical balanced portfolio. Performance of these funds is often a leading indicator for the direct property market, falling more quickly in a downward cycle but then recovering ahead of direct property markets.

The following are examples of direct property funds that we feel are particularly strong.

Aviva Property Trust is an actively managed fund investing in direct property holdings, property shares and derivatives in the UK. The Aviva team is large and well established.

M&G Property Portfolio aims to maximise long-term returns. It focuses on rental progression and a strong lease base through PruPIM’s leverage in the market.

SWIP Property uses market pricing and risk modelling to form top-down views. It uses derivatives to provide flexibility.

Property security funds

First State Global Property Securities fund has a bottom-up focus with a regional overlay. It takes a collegiate approach and uses bespoke external research.

Schroder Global Property Securities has a total return orientation looking for sound financials. It uses high quality property companies, globally diversified

Standard Life Global REIT uses both a bottom-up and top-down approach. It has a strategic view and a valuation-based approach. It is unconstrained and uses local expertise values on site visits.