Property is a good way to diversify an income portfolio
The asset class should be a staple for any income-seeking investor.
By Matthew Jeynes
While the asset class does not receive as much attention as bonds and equities, an allocation to property should be a staple for any investor looking to construct an income-generating portfolio.
This is because investing directly in physical property is primarily designed to generate an income, there is not a huge amount of capital gains to be had from property.
Investing in property comes in two main forms; either investing directly in bricks and mortar buildings or investing in equities that are tied to property, generally things such as real estate investment trusts (Reits).
Both direct property and property equities generate an income, but the property equities are much more volatile and generate a lower income, with most of the funds investing in property equities in the IMA Property sector offering a yield of less than 3 per cent – though they also offer much more prospect of capital returns than direct property.
So direct property is a better bet for investors seeking mainly an income and it can be accessed through both an open ended fund or through a closed-ended investment trust.
Given that an investment trust has a fixed pool of capital, it is a much better route to direct property investing because the manager does not need to worry about selling property assets if investors want to sell out of the fund.
Open-ended property funds need to keep a significant portion of their assets in cash just in case investors want to sell out and this provides a particular drag on the fund’s income.
However, most property investment trusts are currently trading on a significant premium to their net asset value (NAV), often by more than 10 per cent, because the asset class is becoming increasingly popular among investors looking for income following years of record low interest rates.
This high premium could be a negative for new investors because if it drops in the future, that will harm the capital returns on your investment.
In terms of the performance of property investment trusts, any figures based on a five-year performance comparison are bound to be skewed. This is because five years represents the trough of the financial crisis, which struck property investment particularly hard.
This means investment trust discounts ballooned out and the returns in the past five years have been driven significantly by that discount narrowing and going to a premium, rather than the performance of the underlying assets.
The difference means that, according to figures from FE Analytics, while the Picton Property Income trust appears to have been the best-performing trust in the past five years on a share price basis, the best NAV total return has actually come from the F&C Commercial Property Trust.
The £1.1bn F&C trust, which is managed by Richard Kirby, has delivered a NAV total return of 72.5 per cent in the past five years, while the dividend yield is 5.1 per cent.
Two other trusts in the same AIC sector, investing in direct UK property, have a yield of more than 6 per cent combined with strong performance. They are the £190m Standard Life Investments Property Income Trust, managed by Jason Baggeley, and the £291m F&C UK Real Estate Investments trust, which is run by Ian McBryde. On the open-ended fund side, most funds have a yield of less than 5 per cent.
The best-performing fund in the sector – when property equity funds, funds invested in both equities and direct property and fund of funds are excluded – is the £603.4m Scot Wid HIFML UK Property fund, run by Nick Ireland. It has generated a return of 51.5 per cent in the past five years.
However, its yield is only approximately 3 per cent, which is low for a property fund, so those looking mainly for income may want to look at the Threadneedle UK Property fund, run by Don Jordison, which is yielding 4.8 per cent, or the Henderson UK Property fund, run by Marcus Langlands Pearse and Ainslie McLennan, which is generating a yield of 4.2 per cent, according to FE Analytics.
Matthew Jeynes is senior reporter at Investment Adviser
Property: expert picks
Stephen Peters, head of collectives research at Charles Stanley, has tipped bricks and mortar property funds to deliver returns of around 9 or 10 per cent in the coming years, from a combination of both income and capital gains.
He has been buying into two open-ended property funds in particular in recent months, Don Jordison’s £447m Threadneedle UK Property fund and the £2.6bn Swip Property Trust, run by Gerry Ferguson.