UK Property

The managers of the Henderson UK Property Trust, which is on the Chelsea Core Selection, give us an update on the prospects for the commercial property sector:

The property sector has had a tough time over the past five years but, with more encouraging macroeconomic data emerging from the UK, is the outlook now improving?

Recent UK macroeconomic data has been encouraging and positive monthly capital value gains for the overall commercial property market and signs of rental growth mirror the recovery taking place in the wider UK economy. We expect the commercial real estate market to normalise further as we go through 2014. Nevertheless, income is expected to remain a key component of total returns. In London and the South East, for example, there is already evidence that strong occupier demand is supporting notable rental growth. This would be a welcome return to the more traditional drivers of commercial real estate performance: income and capital. Returns, however, remain distinctly split by asset quality and location, highlighting the need for market and tenant knowledge and a focused investment approach.

Are you concerned by interest rates increasing?

When we are shaping the fund we are looking at diversification and having protection throughout the economic cycle, not just in the current environment. The gradual rise of interest rates predicted by financial markets should not be a threat to the commercial real estate asset class in the short to medium term. The low borrowing rate environment, witnessed since the global financial crisis, has improved the attractiveness of income-producing assets, such as bricks and mortar-based property funds.
While there has been a rebound in commercial real estate investment activity since 2010, wider market valuations remain attractive. In fact valuations are below the pricing peak of 2007, providing a sufficient yield cushion should interest rates rise further. Any negative valuation fears attached to a rise in interest rates should be offset by stronger UK economic growth, a recovery in the occupier market, and a subsequent rise in rental growth on commercial property.

When constructing the portfolio what characteristics do you look for in the property and potential tenants?

The five key credentials we consider when purchasing a property are location, lease length, building specification, tenant strength and whether or not institutional-class (landlord friendly) lease terms are in place. If the property has all five of these characteristics then it is deemed to be prime. A property with at least three (but not all five) of these attributes is considered core, which can provide us with greater opportunities to add value through asset management initiatives. For example, we often negotiate existing leases on buildings to deliver longer or more favourable terms. Similarly, a property can be refurbished, or its environmental and technical specifications improved, so that it attracts a better quality of tenant.

What sectors and geographic regions do you currently favour, and are there any you're avoiding?

In terms of location, the fund has a South East bias, where we believe economic growth is set to be strongest, although we continue to find opportunities across the rest of the UK and own some particularly attractive regional properties, such as an office park in Cambridge, a cinema complex in Cardiff and a key distribution unit in the North West of England let to Kellogg’s.

Over the past year the fund has made a number of purchases across a range of sectors, including industrials and selected London offices. Several strong, opportunistic acquisitions were also made in the retail and leisure alternatives sectors. The latter includes gyms and hotels, which provide further diversification and often come with longer-term inflation-linked leases.

We remain light in our sector weighting to high street retailers, but the improving economic environment has led us to increase exposure in key locations such as London, Nottingham, Cardiff and Manchester. Nevertheless, we continue to favour properties that play into current and future shopping trends, such as distribution units and retail warehouse parks for their convenience. Advantages include the ability for consumers to use 'click and collect' services, which are increasingly in demand, and potentially larger spaces to accommodate a fuller range of products.

Important Information:
Due to the specialist nature of property investment, in certain circumstances there may be constraints on the redemption or switching of units/shares in the fund(s). The funds invest in a specialist sector that may be less liquid and produce more volatile performance than an investment in other investment sectors. The value of capital and income will fluctuate as property values and rental income rise and fall. The valuation of property is generally a matter of valuer’s opinion rather than fact. The amount raised when a property is sold may be less than the valuation.