UK Edition
Questor: this property fund trades at a slight premium, but the 5pc yield is just one reason to buy
Our Trust Bargains column has not covered any property investment trusts so far for the simple reason that these portfolios have tended to trade at a significant premium in recent years.
However, we should not ignore property trusts altogether because they can provide valuable diversification and a source of reliable income. So, today we will relax our “bargain” yardstick slightly to cover a trust that has recently started to trade at a small premium to the value of its assets.
The portfolio, Ediston Property, which yields 5pc, was the top pick in a recent report on property funds from the stockbroker Canaccord Genuity.
The report’s authors, Alan Brierley and Ben Newell, pointed out that annual returns from commercial property as a whole were expected to fall to 5.5pc after double-digit returns in recent years. This is because capital growth is expected to all but disappear, leaving rental income as the only source of returns.
As a result, the report said, investors who want to beat the 5.5pc level will have to seek out funds that could get more out of their property assets by developing them so that capital values, rents or both would be enhanced.
In other words, instead of buying properties, letting them out and passively banking the rental income, while relying on general trends in the property market to boost capital values, managers would improve or redevelop their properties to enhance their value.
“This type of ‘asset management’ really is the key to greater returns now that the era of double-digit performance is over,” Mr Brierley said.
“And Ediston Property is the best trust in this respect. It has an entrepreneurial style of asset management and a large number of management specialists. You can’t expect to extract the most value out of your properties if, as some funds do, you have a high proportion of assets to managers. We expect Ediston to outperform the sector.”
The trust, which pays income monthly, commands a small premium of 1.3pc. Mr Brierley said this did not affect his belief that it offered the best prospects among the property trusts.
His report also compared the performance of ordinary “open-ended” property funds with their investment trust counterparts.
It found that over the past 10 years property investment trusts, on a weighted average basis, had gained 41.1pc in net asset value and 58.8pc in share price terms, with income reinvested, compared with a weighted average of 5.5pc from open-ended funds.
Canaccord put this outperformance down to investment trusts’ ability to magnify returns by using borrowed money (“gearing”), whereas open-ended funds were forced to do the opposite and hold large amounts of cash to meet redemption requests.
With gearing, trusts had an effective exposure to the performance of their assets of 124pc, whereas open-ended funds’ exposure was diluted by their cash reserves to just 78pc.
Arguably the strongest reason to prefer investment trusts for your property exposure, however, is that open-ended funds have to buy and sell properties in response to flows of money into and out of their portfolios. This can make them “forced” buyers and sellers.
If a fund attracts a lot of new money, it has to buy properties (or see a bigger proportion of its assets sitting unproductively in cash); if many investors want their money back at the same time, as happened after the Brexit vote, it has to sell properties once the cash reserve is exhausted.
In both cases it is unlikely to achieve the best price.
Investment trusts, which operate with a fixed amount of capital and do not accept new money or meet redemption requests, can afford to assess buying and selling opportunities on their own merits.
We believe that investment trusts offer the best route into commercial property and that Ediston Property is the most attractive trust at this stage.
Questor says: buy
Ticker: EPIC
Share price at close: 109.75p
The property trusts in Questor's 5pc Income Portfolio
- Buy this property company for its 4.4pc yield and monthly payments (F&C Commercial Property)
- These are the first two holdings for my 5pc portfolio (Regional Reit)
Investment trust news
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