Keeping it real

20 September 2016

Despite a more challenging outlook in the aftermath of the EU referendum, we believe that the long-term benefits of investing in UK commercial real estate remain intact. One of real estate's key attractions, particularly with interest rates set to remain low, is its ability to provide investors with a sustainable source of income through rents paid by tenants. While capital values have been impacted by a weaker investment market recently, a modest supply of additional space should help support the rental cycle. Real estate's yield should therefore remain high relative to other assets in the medium term.

For those who consider the current environment as an opportunity to buy into real estate, investment trusts could be a prudent way to gain access. Following the EU referendum, some open-ended property funds have had to suspend trading in order to deal with outflows. However, the closed-ended structure of investment trusts means there is limited scope for high capital inflows or outflows. Instead, their managers can take a long-term view and concentrate on managing their portfolio.

This is certainly the case for Will Fulton, manager of the UK Commercial Property Trust. Will took over management of this FTSE 250-listed property investment company in April 2015, following the acquisition of Ignis Asset Management by Standard Life Investments. Will has taken time to reposition the portfolio; selling assets that he thought offered limited return prospects or required significant capital expenditure for no reward.

In their place, Will bought assets from the prime, high-quality end of the market. This included assets that already offer good prospects for longer-term income (circa 5-6% annually), such as the Cineworld Cinema Complex in Glasgow with its 20-year lease. Will also bought assets where lease lengths were shorter but where there are opportunities to add value through active asset management and unlock income potential. An industrial estate in Radlett, located beside the M25 just north of London, is one example.

Following the transactions, Will believes the portfolio is in a much stronger position. Industrial properties, which we believe currently offer good income with some growth potential, now make up 31% of the portfolio. With limited exposure to City of London offices, which we expect may suffer most from the uncertainty faced by financial service occupiers operating across Europe, Will recently, and before the referendum result, further reduced his London office holding by selling a low yielding 'trophy property' next to the Ritz in London's St James's. His overall UK Office exposure is 23%. Holdings in the retail sector were reduced from 45% of the portfolio to 36% with longer leisure investments making up the 10% balance.

Looking ahead, the Trust is well positioned in the current environment. It offers desirable defensive characteristics, such as a portfolio biased towards prime properties, a low vacancy rate (2.8%), a diverse tenant base, a strong balance sheet with low gearing and significant cash resources. A dividend yield of 4.6%*, compared with around 0.6% for UK 10-year gilts, also makes it attractive from an income perspective. Priced at a 6.9%* discount to net asset value, the UK Commercial Property Trust could provide the answer for investors willing to take a long-term view on the undoubted benefits UK real estate can bring.

*Source: Standard Life Investments, as at 25 August 2016. All others figures as at 30 June 2016