Explaining what makes property an ideal portfolio component and why now is a good entry point for real estate investors
Why property?
Commercial property has long been an attractive option for investors wanting to add returns potential and/or enhance diversification within broader portfolios.
- Attractive income – real estate can provide an attractive and reliable income. And unlike other asset types the yield isn’t ‘fixed’ with scope to increase thanks to rental growth.
- Growth potential – high occupancy levels in select sectors can combine with long-term structural demand drivers and a lack of new supply to boost property valuations. Just look at capital appreciation in the logistics and industrial subsectors in recent years.
- Lower volatility – physical real estate is typically less volatile than the likes of equities and credit. With markets set to remain volatile its inclusion in a portfolio can serve to dampen the impact of fluctuations elsewhere.
- Inflation protection – in Europe, rents are typically index-linked which better protects earnings from inflation and preserves the value of investor capital. Index-linking is increasingly the norm in the UK.
In equities we emphasise companies paying attractive dividends and within physical real estate have a bias to smaller lot sizes with shorter lease lengths – a portion of the market typically offering higher rental income.
And why now?!
After challenges through 2022-2024 we are seeing increased interest from investors – and with good reason. As ever, we strongly believe in an active approach through asset allocation, stock selection and physical property management.
- Past peak rates – with inflation heading back to around target levels central banks are adopting a more accommodative stance. In the previous four cycles real estate equities enjoyed a period of meaningful outperformance relative to the wider stock market when rates start to fall.
Performance of global real estate equities vs global equities - after the last four cyclical peaks in interest rates
Source: Columbia Threadneedle Investments. Data as at 05.09.2024
- Fundamentals are in good shape – we are active investors (whether in physical or listed real estate) and seek opportunities in subsectors and locations where supply is constrained and demand high. High end retail, logistics, industrials and select office spaces are just some of the areas enjoying strong fundamentals. In these conditions, we can tap-into attractive (and growing) yields together with scope for a capital kicker.
- Attractive valuations – with underperformance post 2022 the FTSE EPRA Nareit Europe Index stands at a 31%1 discount to net asset values. Increased transaction activity suggests that asset values have broadly settled, and we think there’s scope for discounts to narrow significantly.
How are we positioned?
We are diversified by geography and sector with European-listed real estate accounting for around half the portfolio. The other half is split between listed UK property and UK physical assets. Across our physical and listed allocations there is relatively high commonality from a sector perspective with a bias towards industrials, logistics and retail warehousing.
In Europe, geographic allocations are a function of bottom-up stock selection. There is a reasonably high weighting to France, for example, but that is because we like select opportunities such as Paris’s high-end office sector where we can find high yielding quality businesses. Conversely, we are less exposed to London offices for the simple reason that yields just aren’t as attractive.
