Although UK commercial property has been an out-of-favour asset class since the Brexit vote last year, investors should not overlook the sector as a source of reliable income. On top of generating an attractive and steady income stream from rents, commercial property offers the benefits of diversification and the potential for meaningful capital growth.
What’s more, there are many listed real estate investment trusts (REITs) trading at steep discounts to their book values, meaning investors can get a slice of the commercial property market on the cheap.
Defensively positioned
Landsec (LSE: LAND) today reported a 5.2% hike in underlying profit in its first-half, following high levels of leasing activity and healthy rental contribution of recent acquisitions and newly completed developments.
The company, formerly known as Land Securities, has a good track record of developing and managing its assets. But looking ahead, it warned about the impact of Brexit headwinds on the economy. Rental values have already weakened slightly in the London office market, and worse may still be to come.
But despite the uncertain macro backdrop, the company is seeing only a slight uptick in its vacancy rate — it rose by just 0.1 percentage points to a still-low 2.9% in the first half of 2017. And going forward, the group is defensively positioned, as demand for higher-value properties has historically been resilient throughout the cycles.
The balance sheet is in good shape too, with a loan-to-value (LTV) ratio of just 25.1%. What’s more, thanks to its recent refinancing efforts, the group has an average debt maturity of 15.1 years, with fixed interest rates determining 97% of its value. This high proportion of fixed interest rate loans and its long-dated maturity structure should help Landsec to reduce near-term exposure to refinancing risk and better withstand future interest rate increases.
As such, I reckon rental income is likely to shine through in the coming year and remain high enough to keep NAV and dividend growth on the positive side. And if you’re looking for another reason, valuations are cheap too — the stock trades at a 35% discount to NAV and yields 4.3%.
Solid earnings growth
Also offering impressive income in the commercial property space is Schroder Real Estate Investment Trust (LSE: SREI).
The REIT’s focus on higher growth locations has paid off as it recently announced an impressive 10.3% increase in its first-half EPRA earnings, a measure of underlying profits which strips out valuation gains. And thanks to its resilience, SREI has been a top-performer in the commercial REIT sector, with shares in the trust up 8% year-to-date.
Looking ahead, the company has an eye on growing its income, by targeting investment in higher-income-producing assets and increasing its exposure to faster growing locations. I reckon these asset management opportunities would help it to sustain its outperformance against its peers.
On the downside, SREI trades at a much smaller discount to its NAV of just 6%. Still, it offers inflation-beating potential, as demand for good quality, well-located assets is likely to hold up well amid ongoing political uncertainty and cyclical risks. The REIT also offers a 4% yield, with dividends covered nearly 1.2 times by underlying rental income.
