Property – yield is important but there are other reasons to invest

3rd December 2013 by The Harried House Hunter

With interest rates remaining at record lows, equities suffering yield compression and investors nervous of bond markets, they are increasingly having to look beyond the major assets classes to find both yield and value. One sector that has come back into vogue over recent months is the physical commercial property market. In fact, we recently surveyed our clients for their likely next investment and property scored more highly than both fixed income and emerging market funds. I know retail investors are supposedly renowned for buying at the top and selling at the bottom, but in this instance I think they may have a point, at least over the short to medium term.

The obvious catalyst for renewed investor interest in the sector is the attractive relative yield that property can offer. In fact, one fund which has recently experienced significant inflows has seen the proportion of investors buying income units (as opposed to accumulation units) increase, which indicates the hunt for yield is contributing to flows. It is easy to see why this may be the case, as a number of property funds yield above 4%, which compares favourably with both UK equities and benchmark 10-year gilts. While the income characteristics of property are well understood, I thought it may be helpful to analyse other factors that also make the sector attractive.

Diversification Characteristics

A falling correlation with equity markets continues to highlight the strong and improving diversification characteristics of property. Also, property prices are significantly less volatile than equity markets. In short, the addition of property funds to a portfolio could potentially enhance the yield and lower the risk profile.

Capital Growth

In recent years income has been the primary driver of returns and, while I expect this to be the case going forward, there is some evidence of increased activity in the property market. I’ve heard anecdotal evidence of multiple bidders when properties go on sale, which is something that the market (outside of prime central London) has seen very little of in recent years. This has resulted in many industry experts revising up their forecasted total returns, with around 8% p.a the consensus figure for the next three years.

Value

Many property investors who got caught up in the debt-fuelled hysteria of the mid-2000’s will no doubt have bad memories, with funds losses and, in some cases, suspending dealing after the property bubble burst. However, with the exception of prime central London, property has lagged behind many of the other asset classes since then and, despite the recent pick up in interest in the sector, it still looks relatively cheap.

Improving economic environment

The surprise up-tick in the UK’s headline GDP growth figures should see some confidence return to the sector. Also, this should feed through to rental growth, which traditionally lags improvements in the economic environment. Supply also remains constrained, with the development pipeline extremely muted at present.

In summary, there are many reasons to like property at moment, other than the obvious draw of an attractive relative yield. The sector has defensive characteristics, due to its low correlation to equities and low volatility. Also, on some indicators, the sector still offers value, which is not to be sniffed at in the current climate.

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’ views are his own and do not constitute financial advice.

Leave a Reply

Your email address will not be published. Required fields are marked *