In today’s low growth, low interest rate environment generating a sufficient level of income from investments can prove tricky. With bank deposits paying next to nothing and traditional income-paying assets such as equity income funds not always able to deliver the amount of income investors require, people may need to look further afield in order to identify good income sources.
In the first part of our three alternate sources of income series we looked at infrastructure. This time the focus is on property.
Commercial property performance
After a period in the doldrums, UK commercial property was one of the best performing asset classes in 2014. While in the long term this level of performance may not be sustainable, the reasons behind the improvement in performance remain largely in place.
A combination of constrained supply and stronger demand means almost all areas of the UK property market are now experiencing rental growth. Offices in London and the South East continue to enjoy the strongest growth.
Commercial property fund managers are optimistic that property should continue to deliver positive returns over the medium term.
Past performance is not a reliable indicator of future results
Source: Morningstar Direct from 1 January 2005 to 31 October 2015. All returns in GBP.
Income is attractive
- The income yield on property remains attractive, in the view of M&G Investments; which runs the M&G Property Portfolio. Against a backdrop of very low returns from other income producing assets such as government bonds and cash, the yield available from property investment can be compelling for income-orientated investors, says M&G.
- Legal & General Investment Management (LGIM), which runs the L&G UK Property fund, notes that while yields on UK commercial property are currently lower than historical averages the low level of interest rates means the additional yield from property is still relatively high.
- The Bank of England has said the “new normal” for base rates may be closer to 3%, and LGIM believes yields are consistent with the level it would expect them to be once interest rates have normalised.
- The asset class can also help to guard investors against inflation, given the potential for income growth over time.
High quality tenants
The main source of performance from commercial property is normally the rent paid by tenants – over the long term this can make up as much as 70% of the total return. Rental payments are made on a regular basis as set out in the lease agreement, just as they are when people rent residential properties.
Commercial property has two big advantages over residential when considering income. The leases tend to last much longer and there is usually a better chance of the rent being paid, as businesses are generally more reliable tenants with access to larger sums of money.
- In the last year, for example, M&G Property Portfolio acquired a shopping centre in Maidstone for £110 million which has tenants of the calibre of House of Fraser, Superdry, Top Shop, Boots and JD Sports.
Leases on commercial property can be for five or 10 years – sometimes even longer – which means a commercial property investment offers the scope for regular income that lasts the life of the lease.
- Another shopping centre held in the M&G fund, the Gracechurch Centre in Sutton Coldfield, saw fashion retailer Fat Face take a 10-year lease on a shop. What is more, rental rates are normally reviewed every five years and, in many cases, the rent can only be revised upwards. All this adds up to a predictable and reliable income stream for investors in commercial property.
There has been some volatility in capital growth across the property sector over the last few years, but in the main, property funds have continued to pay out a good and steady level of income.
M&G Property Portfolio and L&G UK Property fund are both on our recommended list. You can find out more information about each of them below or click on one of the graphs for a more detailed look.
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