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Time to index-link your income?

The shift from ‘transitory’ to ‘persistent’ has seen central banks pivot into tightening mode to counter higher inflation. As a result, many fixed coupon bond values are set to become less attractive. The solution? We think a selective and active approach to property investment might just be the answer for those seeking attractive real yields.

Securing ‘real’ income with real estate

As real estate investors, we can be relatively sanguine on the impact of higher inflation on our investments. In our Property Growth & Income Fund, our investments comprise both listed real estate companies and the buildings we own. Much of a physical property’s return is derived from rental income from underlying tenants. In Europe, these rents are typically index-linked, thus protect earnings from inflation and this is increasingly becoming the norm in the UK. This is a reassuring buffer, with earnings essentially maintaining their real value.

Rental growth – location matters

The supply of land is fixed, meaning that properties in locations with the right supply/demand dynamics can enjoy rental growth – a trend that can drive attractive real yields as well as scope for capital appreciation. As economies continue their recoveries, these dynamics become more pertinent, and whether investing in real estate securities or physical property, we’re fully focused on orientating our exposure to the right sub-sectors and locations.

Experienced management operating in attractive sub-sectors

The listed European real estate universe provides us with an opportunity set that’s broad and diverse, meaning we can target quality businesses run by proven management teams operating in supply constrained areas. Currently, for example, we’re overweight industrials/logistics property through names like Warehouses De Pauw, Segro and Tritax Big Box REIT, and favour sectors like German residential and supermarkets, again accessed through select businesses. The quality of companies we invest in is key, with management experience and incentivisation forming a big part of our criteria. Savvy management teams will have already moved to fix their long-term debt costs, diffusing the threat of higher interest rates, whilst positioning themselves to benefit as economic growth gathers pace.

Our take on bricks & mortar

Similar principles apply to physical property. Avoid areas like traditional high street retail and tap into structural real estate trends. Industrial and logistics assets form the bulk of our exposure – premises located near good transport links and where supply constraints exist. Active management matters and it’s important to build strong relationships with our tenants. If we understand their businesses and needs, we can better retain (and grow) our rental income, both at lease expiry and when break options arise. Additionally, our bias towards smaller lot sizes with shorter leases allows us to capture revisionary income faster. This is an advantage when prices are on the up.

Future thinking

As the world emerges from the pandemic, we see several accelerating real estate trends. The way we work has evolved and so have the demands we make of the built environment. Traditional office spaces may not be appropriate for hybrid working practices, and the commitments companies are making on their transition towards net zero will see them expect buildings that perform well from a sustainability perspective. Premium rents will be paid for best-in-class buildings and we’re already seeing opportunities arise as the green building development super cycle gathers pace.

Final thoughts

Inflation looks set to remain a feature throughout this year and into next – a factor that makes protecting returns from its eroding impact an important consideration for fund selectors and portfolio constructors. We believe that real estate provides an option for those seeking a yield that’s attractive in real terms. Plus, it offers potential for capital growth. The importance of selectivity and active management shouldn’t be underestimated, however, as not all sectors, property businesses, individual properties or indeed property funds are created equal.

10 February 2022
Marcus Phayre-Mudge
Marcus Phayre-Mudge
Fund Manager
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Risk warnings

Views and opinions expressed by individual authors do not necessarily represent those of Columbia Threadneedle Investments.

The value of investments and any income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested.

Past performance should not be seen as an indication of future performance. The value of investments and income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested.

The value of directly-held property reflects the opinion of valuers and is reviewed periodically. These assets can also be illiquid and significant or persistent redemptions may require the manager to sell properties at a lower market value adversely affecting the value of your investment.

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