UK Commercial Property: Tangible Income Expectations
In this video update, Ainslie McLennan, co-manager of the Henderson UK Property PAIF, highlights that rental income remains the foundation for investing in the asset class and reveals how the fund is positioned as we head into 2017.
• What lessons have you learned from 2016?
2016 has been an extraordinary year for our investment team and the UK commercial property market in general on the back of the UK’s vote to leave the European Union. The strong lesson for us has been to stick to our management approach of maintaining a core, defensive, income-focussed portfolio of high-quality assets.
During the period when dealing in the fund was suspended we took the opportunity to raise cash levels in an orderly fashion by selling a number of assets. From an investor perspective, this resulted in the crystallisation of good performance on properties that were sold, while retaining a portfolio of high-quality assets. This meant not compromising on quality despite what was happening at a broader economic and political level.
• What are the key themes likely to shape the markets in which you invest in 2017?
During 2017 the area of the market that is most likely to experience declines in capital values is City and West End of London offices. Therefore, we have significantly down weighted the fund’s allocation to London offices, particularly to those with tenants operating within the financials sector. This is based on concerns surrounding the process of Brexit and whether London will continue to act as a European hub for the financial services industry.
We are aiming to maintain a strong liquidity buffer*, income protection and, where appropriate, income growth. We aim to be as steady as possible in terms of income from the PAIF and its associated Feeder Fund so that distributions are meaningful and helpful to investors. This means retaining a firm focus on good locations, depth of occupational demand, quality of tenant, lease length, lease structure, and building specification.
* Comprising cash and some property equities
• What are your highest conviction positions moving towards the new year?
Areas we have down weighted include London offices from which we sold approximately £380m of assets during and since the summer. This was a specific de-risk position and a result of strong performance at an asset level. In terms of regional offices, we do like the South East as a location, which we feel offers better rental income protection compared to other UK regions.
We also like and have maintained a sensible weighting to the logistical and industrial distribution markets in all geographies across the UK where good infrastructure is in place. The alternatives sector, which includes assets such as gyms, care homes, cinemas and data centres, is also favoured. Both areas often come with long leases.
• What should investors expect from your asset class and your portfolio going forward?
Income, income, income. In this extended low interest rate environment income remains a key component of returns from commercial property and a clear focus for the Henderson UK Property PAIF.
Approximately 25% of the fund’s rental income is generated from tenants with lease structures that either have fixed increases (kickers) or Retail Prices Index-linked increases in place, which should be beneficial with inflation back on the radar.
It is reasonable to expect softer economic performance into 2017 as markets react to anticipated Brexit negotiations. Overall, however, we believe the asset class remains attractive as a portfolio diversifier, given its supply of steady contractual rental income, underscoring the case for high-quality, well located commercial ‘bricks and mortar’ assets.
Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
The information in this article does not qualify as an investment recommendation.