AIC: Outlook for property investment company sector

Investment companies in the Property sector turned in another set of impressive returns in 2006, with the average company up 18% in share price terms, according to the AIC (Association of Investment Companies).

With the average dividend yield currently 3.9%, it’s easy to see why this sector has proved so popular. Like REITS, they also have significant tax benefits.

Certainly 2006 was a bumper year for property launches, with over a third of the £2.7bn raised by new issues in the closed ended sector coming from the Property sector. Even so, the property investment company sector has experienced a re-rating over the last six months, and on average has fallen from a premium of +3.6% a year ago to a discount of 0.4% at the end of December 2006.

With REITS making their debut on 1 January 2007, many anticipated a ‘brave new world’ when it came to property investment. Yet with this already factored into REIT share prices, the reality has so far been more muted.

What is the outlook for the property investment company sector? And what are the characteristics of property investment companies? This week, the Association of Investment Companies (AIC) hosted a press roundtable lunch on the outlook for the property sector with Duncan Owen, Manager, Invista Foundation Property Trust and Elliot Caldwell, Manager, ING UK Real Estate Income.

Duncan Owen suspects that property returns in 2007 could surprise on the upside, possibly even breaking 10%, although he expects to see a greater divergence of returns with both winners and losers. Elliot Caldwell expects the property sector to return 11% in 2007, whilst Richard Kirby, Manager of F&C Commercial Property Trust, who the AIC has also spoken to,expects total returns to moderate in 2007 and a period of single digit returns is in prospect for the next few years.

Elliot Caldwell, Manager, ING UK Real Estate Income said: “We expect investors’ appetite for commercial property to remain strong during 2007. A considerable wall of capital is still targeting UK property and the excellent recent performance will keep it high on the wish list for many investors.

“The UK economy rebounded strongly in 2006. Consumer expenditure remains sluggish and this explains why retail property’s performance slipped below industrial properties last year. The financial sector is growing strongly, which coupled with a lack of office supply particularly in Central London explains why offices are now the top performing sector. We anticipate that this performance hierarchy will continue this year. Accordingly, we forecast that UK commercial property portfolio returns will moderate to a healthy 11% this year.

“Any outlook for 2007 cannot fail to mention the introduction of real estate investment trusts. We believe investors and advisors will welcome a vehicle which provides increased liquidity to the asset class. However, UK REITS are still more restricted than those of the offshore sector and the regime may therefore dissuade some from going down the UK onshore REIT route. The offshore investment company offers a less restricted viable alternative. We believe over time, the performance between offshore investment companies and UK based REITS will be more influenced by the performance and the quality of the managers than the jurisdiction of domicile.”

Duncan Owen, Manager, Invista Foundation Property said: “It’s too simplistic to say property is overvalued. This is a diverse asset class, and whilst parts may be overvalued, others are not. Property returns may well surprise on the upside in 2007, and may yet break 10%. However, there will be winners and losers and we are likely to see more divergence of returns between sub sectors going forward. Those funds with a strong management team and diverse portfolios are likely to thrive, but there will also be casualties.”

Richard Kirby, Manager, F&C Commercial Property Trust said: “The property market has seen total returns in the high teens for the third consecutive year, helped by strong inflows of money into property. There is no sign that investor appetite for property is waning and it could be supported further by the introduction of UK REITs. But yields have been pushed down to very low levels and there is little scope for further falls, especially as interest rates move up in the UK. F&C expects total returns to moderate in 2007 and a period of single digit returns is in prospect for the next few years.

“The market could see some correction, especially for secondary stock as the market adjusts to a new environment where income returns and rental prospects assume a greater importance in driving total returns. We expect property to remain in favour with investors reflecting its role as a diversifier and also its development as a major alternative asset class, helped by the evolution of a greater range of investment options for investors – by risk profile, liquidity, fund type, country and asset mix.”

Annabel Brodie-Smith, Communications Director, Association of Investment Companies (AIC) said: “The closed ended structure of investment companies lends itself well to investing in the property sector, because managers are not forced to sell property, an illiquid investment to meet redemptions.

“Investor appetite for commercial property seems to show little sign of abating, and it is certainly a tangible asset class with some attractive yields, as well as potential for good capital growth. Even so, it is worth remembering that despite the strong performance of property over the last ten years or so, this can be a cyclical sector and it’s important to have a balanced portfolio. With fund managers expecting to see a greater divergence of returns going forward, the need for investors and advisers to do their homework and pick the right management will also be paramount.”