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Questor: This fund is our pick of the property Reits

Employees process customer orders ahead of shipping at a warehouse
Picton's £525m property portfolio is split between industrial, office and retail warehouse investments - Simon Dawson / Bloomberg

The launch of Special Opportunities real estate investment trust (Reit) that we wrote about two weeks ago has flopped, with the company failing to raise the £250m it wanted to buy commercial property portfolios being sold cheaply by pension schemes.

Investors baulked at putting money into a new fund when interest rates are still high and six existing Reits investing across the UK real estate market can be bought at bargain prices.

With that avenue closed, the question is, with shares in generalist listed property funds trading 27pc below asset value, which should you choose?

The abnormally wide discounts present a good opportunity with real estate recovering after a two-year slump.

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In most areas, commercial property prices are stabilising and rents growing – particularly in industrial parks and warehouses where there is limited new supply – although the office sector remains challenged by working from home and the cost of environmental standards.

Consensus forecasts compiled by the Investment Property Forum predict total annual returns of 7.5pc from UK real estate in the next five years. These range from more than 8pc for industrial properties and retail warehouses, 7.2pc for shopping centres and 5.8pc for offices, though London’s West End and City are expected to do slightly better.

There’s also the potential for more bids to liven up depressed Reit stocks following UK Commercial Property’s acquisition by Tritax Big Box last month and LondonMetric’s purchase of CT Property last year.

Analysts recently provided some guidance to the Association of Investment Companies on which UK generalist Reits investors should buy. Yields of 5-9pc look attractive but Andrew Rees of Deutsche Numis said: “You need to check how they [dividends] are being paid – from earnings or capital – and if they are fully covered.”

Emma Bird at Winterflood Securities added: “It is important to note that earnings growth is a function of rental growth but also costs, so if they have rising costs (such as vacancies, debt, capital expenditure) this can impact earnings negatively even if rental income is growing.”

Surveying the latest financial results from Reits, three generalists stand out.

First is Custodian Reit on a 21pc discount after an attempted merger for rival Abrdn Property was backed by a majority of shareholders but failed to gain the necessary 75pc support. That looks great value for a diversified £412m portfolio of smaller properties outside London that is 40pc invested in industrials and 23pc in retail warehouses.

With a 5.5pc increase in covered dividends last year, the company is targeting a 9pc rise in the payout this year to 6p per share. This gives a prospective yield of 8.4pc that shows confidence in the prospects for rental growth. Debts are relatively low at 29pc of assets with interest costs mostly fixed over five years.

Next is Schroders Real Estate, a £459m portfolio chasing a “green premium” by making its properties carbon neutral and energy efficient. It also paid a covered dividend in the year to March and with the target lifted to 3.4p per share this year offers a 7.8pc yield. On a 23pc discount the shares look attractive, particularly with a 61.5pc exposure to industrial estates and retail warehouses.

Development opportunities at its trading estate near Stockport, a Salisbury retail park and Bloomsbury, central London underline the potential for strong income and capital growth. However, some disposals are needed to reduce its largely fixed-rate debt from 37pc of assets.

Last, but not least, is Picton Property Income. The £525m portfolio, split into 59pc industrials, 30pc offices and 7pc retail warehouses, is our pick of the crop. Despite beating its commercial property benchmark for 11 years in a row, with 153pc growth in net asset value over 10 years, the shares languish on a 30pc discount.

Last year’s dividend was 1.1 times covered by earnings and, with the quarterly dividend raised 5.7pc to deliver 3.7p this year, the shares yield 5.5pc. Although below the other two, with estimated rental value 29pc above current rents, Picton’s overall growth prospects look brighter.

Marcus Phayre-Mudge, manager of TR Property, which we tipped in April, praised Picton’s “fantastic debt structure” with borrowings under 27pc of assets entirely fixed and with its £50m overdraft repaid after the sale of two offices in London and Cardiff. Phayre-Mudge, who holds 2.8pc of his trust in Picton, suggested Picton “could buy back a significant amount of its own shares” that could help re-rate the stock.

While Custodian and Schroders may attract income seekers, we believe Picton could generate higher total returns.

Questor says: buy Picton Property Income

Ticker: PCTN.L

Share price: 66.7p

Gavin Lumsden is editor of Citywire’s Investment Trust Insider website 


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