Taking income higher with real estate

The ability of real estate to generate a high and dependable income and withstand economic volatility continues to make it an important element of many investors’ portfolio, provided they choose assets carefully.

 

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Many of us are inclined towards real estate investing because the asset class is a familiar feature in our daily lives. The way we shop, receive goods, work and enjoy leisure time all support the underlying real estate economy.

Investing in real estate tends to produce a relatively high and dependable income stream. Over time, investors can typically expect around 75 per cent of the return from real estate to come from the rental income paid by tenants. The remainder comes from the potential growth in value of the real estate assets. This could be through improvements made to the assets, or market value appreciation, or both.

If the tenants sign leases that extend for many years, a portfolio of diversified real estate assets can offer highly predictable income. Moreover, it should be able to withstand short-term economic volatility. For this reason, investors typically use real estate to help diversify their portfolio, with risk-reward characteristics that lie somewhere between equities and fixed-income investments.

Demand for income strategies

In recent years, there has generally been growing interest in income-oriented investments. Fixed-income investments, such as UK government gilts and investment-grade corporate bonds, are considered a comparatively low-risk source of income. However, with interest rates at persistently subdued levels, they currently offer only modest returns. By comparison, real estate can provide both higher income and more secure strategies. As a result, we see many investors keenly seeking income-oriented real estate strategies.

It also is notable to see the high regard investors place on real estate assets with long-term secured leases. In some parts of the market, tenants are demanding more flexible and variable lease terms. However, this is not universally the case and strategies can easily be set that target dependable income.

Prospects for real estate

The investment prospects for real estate are driven by a variety of factors. Perhaps most important is the income that a real estate asset can generate. Investors therefore need to consider what’s driving – or what’s hindering – real estate’s income-generating potential. Below, we quickly assess the ‘fundamentals’ currently affecting the four main sectors of the UK real estate market – the outcome of Brexit notwithstanding:

The retail sector

The challenges facing the UK retail sector have become a regular feature of news headlines. As shopping shifts online, the diversion of retail goods and services away from some high streets and shopping centres alters the affordability of rents. As a consequence, retail real estate rental values are being challenged. We can expect this to continue. However, it would be clumsy to suggest it is true of all retail assets. We strongly believe that convenience-oriented retail – by which we principally mean supermarket-led and accessible out-of-town retail – will remain strongly viable.

This part of the market is typified by affordable rents contracted against financially resilient tenants. These tenants generally have considerable flexibility in how they operate their businesses. Clearly, then, there are parts of the retail real estate market that will retain good value.

The logistics sector

The structural changes in retail are in turn causing fundamental changes in the way that goods are stored and  distributed. The resultant growth in demand for logistics properties, such as warehousing, has been phenomenal in recent years and shows little sign of abating. Particularly notable has been the recent and projected real growth in rents and values in urban locations. Quite simply, logistics businesses are expanding and being forced to shift ever closer to their consumers. This is creating urban areas where rents and land values are underpinned by a wide variety of competing land uses.

Aberdeen Standard Investments recently completed primary research of some 130 logistics businesses across Europe. Among the findings, the report highlighted a clear trajectory of ongoing growth in demand for logistics space – and particularly for more urban and flexible, modern logistics buildings.

The office sector

The growth of urban populations provides notable indirect support for the office market as well as for the logistics sector. The removal of obsolete office space for conversion to higher-value, typically residential use is positive for the office market. Government legislation has increasingly facilitated this shift, which is now being extended to outmoded retail property. The resultant decrease in vacant space means that prospects for well-designed, well-located office buildings have generally improved.

We are mindful of other disruptive changes affecting the office sector, such as more flexible working patterns and the trend towards higher-density occupation. But where these trends are evident, the affordability of rents in the right buildings remains well-supported.

Alternatives

Perhaps the most compelling areas of the real estate market are those that are less explored by general investors. These so-called “alternatives” include student housing, budget hotels, data centres, pubs and leisure premises.

These assets can exhibit many appealing characteristics such as long-term, contracted income streams, often with fixed inflationary adjustments. The underlying tenants also tend to be financially robust. Alternative real estate assets are becoming more available to investors and now account for over 10% of the UK real estate investment market. Potentially, we see the market extending to health and a wider range of residential-related property too.

Focus on quality

In short, the UK real estate market – like the global market – is undergoing some important shifts as shopping, working, living and leisure patterns change. Finding the real estate assets that are going to thrive in this shifting market demands an active focus on quality – be it the quality of buildings, location or tenants. But the appeal of quality real estate assets as a potential source of reliable income and portfolio diversification remains as strong as ever.

Our property investment companies

Aberdeen Standard Investments manages assets for three property investment companies:

  • Aberdeen Standard European Logistics Income PLC: aims to provide a regular and attractive level of income return together with the potential for long-term income and capital growth by investing in European logistics real estate.
  • Standard Life Investments Property Income Trust Limited: aims to provide an attractive and growing level of income along with the prospect of capital growth by investing in a diversified UK commercial property portfolio.
  • UK Commercial Property REIT: aims to provide an attractive and growing level of income together with the potential for capital growth by investing in a diversified portfolio of UK commercial property.

Important information

Aberdeen Standard Investments is a brand of the investment businesses of Aberdeen Asset Management and Standard Life Investments.

Risk factors you should consider prior to investing:

  • The value of investments and the income from them can fall and investors may get back less than the amount invested.
  • Past performance is not a guide to future results.
  • Investment in the Company may not be appropriate for investors who plan to withdraw their money within five years.
  • The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
  • The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
  • Movements in exchange rates will impact on both the level of income received and the capital value of your investment.
  • There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
  • As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
  • The Company invests in emerging markets which tend to be more volatile than mature markets and the value of your investment could move sharply up or down.
  • Specialist funds which invest in small markets or sectors of industry are likely to be more volatile than more diversified trusts.
  • Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.

Other important information:

Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1XL. Registered in Scotland No. 108419. An investment trust should be considered only as part of a balanced portfolio. Under no circumstances should this information be considered as an offer or solicitation to deal in investments.

For more information, please visit https://www.invtrusts.co.uk

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