F&C Property predicts strong year

The trust's manager, Richard Kirby, expects that 2014 will be a strong year for commercial property. "We expect a total return of about 14.5 per cent and a five-year total return of around 10 per cent," he says. "This is fairly attractive and outpaces the 10-year long-run average. But what we need moving forward is for income returns to increase and rental growth on a far wider basis. However, we are well positioned in good quality property that tenants want, which is set for rental growth, including in central London."

He says tenants are more confident, and are looking to expand and secure space. "There is also a significant weight of money from across the globe chasing property investments while over the last four to five years there has not been much building or development, so it is in short supply," he adds. "Rental growth is recovering, something we haven't seen for four to five years. The pockets we are seeing should feed out but I expect it will be mainly in prime and good secondary property."

In later years he expects performance will be more about income return plus some rental growth. "The quality and longevity of income is key," he explains.

Mr Kirby thinks central London, where F&C Commercial Property has some conviction positions, will outperform. However, competing with other property hungry investors creates challenges as he is unwilling to pay the aggressive levels being bid. "My biggest challenge is deploying capital, because you have lots of property chasing investors," says Mr Kirby. "There are lots of open-ended funds under pressure to get their cash invested and we are struggling to compete in core central London with international capital. So we are looking to new areas such as the South Bank, Vauxhall and Bermondsey."

He also thinks there is value in major cities such as Manchester, Birmingham, Bristol, Edinburgh, Glasgow and Leeds.

"Our strategy has been evolving over the last 18 months and we have reduced our central London exposure and moved into the regions, for example, our recent purchase of office blocks in Aberdeen and a distribution centre in Liverpool," he explains. "The distribution centre has a good tenant - Johnson Controls Automotive - which supplies Jaguar Land Rover."

This distribution centre cost £11.9m, reflects a net initial yield of 6.45 per cent and is being let for 15 years.

He likes retail warehouses and recent purchases include two at Oakenshaw Road in Solihull let to retailers Magnet and Multiyork Furniture. They have a weighted average unexpired term of 8.4 years and purchase price of £4.5m which reflects a net initial yield of 6.9 per cent.

"We will go opportunistically up the risk curve, for example, where we can reposition an asset," he says. "We look at and appraise every opportunity but are very disciplined in what we buy. Understanding the individual property, local markets and demand is important. This includes modelling cash flows and working on internal rate of return targets. We try to spot something that is undervalued or an opportunity to add value, for example, refurbishing it, re-gearing it or re-letting it at a higher rent to a better tenant."

In 2013 Mr Kirby and his team conducted nine rent reviews with a total uplift of £300,000 a year over the previous passing rent. The trust's largest holding, St Christopher's Place in London, is being refurbished, and planning permission has been secured to redevelop 71 to 77 Wigmore Street, which should start in 2015.

"As well as more of a regional bias we would like to do more development and move the trust a bit up the risk curve," he explains. "However, if development fails it can have a detrimental effect so we will not invest more than 10 per cent of the portfolio in development, and only in ones we believe we can let at the rents we expect."

With buyers piling into property and driving up prices some have concerns it is going too far. "We may well get some segments that are over bought but where we are should be sustainable in an improving economy," says Mr Kirby.

The trust's properties have voids of around 6.5 per cent, which analysts at Investec say is at a five-year relative high. But Mr Kirby says this is below the market average level of 10.9 per cent. "Lots of our stock is under offer so we are not overly concerned and expect the level of voids in our portfolio to fall," he adds.

At the Sears Retail Park in Solihull, for example, a unit that became void after electrics retailer Comet went into administration has now been re-let to Next Home & Garden on a 15-year lease, while a void created by the insolvency of JJB Sports is about to be re-let.

Analysts at Numis say that "F&C Commercial Property has delivered the most consistent NAV performance of the peer group in the recent years, with the last NAV decline in the second quarter of 2012. This reflects its large weighting to London and exposure to prime assets."

Analysts at Liberum, meanwhile, rate the trust 'BUY' and comments that its "30 June NAV was 1.2p ahead of our 113.9p forecast."

F&C Commercial Property typically trades at a high premium to NAV and had mostly been on a double-digit premium for more than a year. However more recently it has fallen back to a premium as low as about 5 per cent, and is currently 8.75 per cent. Mr Kirby attributes this to the release of strong second quarter NAV growth that had closed the gap with the share price a bit, and adds that the market has been choppy.

The trust has debt of around 24 per cent of its assets but this is unlikely to rise above 30 per cent. It has £230m in bonds and a £30m bank loan which will mature in June 2015, and its board is considering various options to refinance them, either at that date or sooner. The trust's board says "the current low interest rate environment and quality of the portfolio make it well placed to refinance on attractive terms."

The trust has received offers to refinance from insurance companies and banks, and is looking at issuing bonds. Considerations include pricing, tenor and flexibility, and there may be an announcement on the debt refinancing in the next month or two.

The trust's board is also looking at whether to convert its structure to a real estate investment trust (Reit). It said in the annual report that "We remain satisfied that for the time being it continues to be in the [trust's] interests to maintain the current group structure but this could change, particularly in light of any structural changes which may take place as a result of refinancing the debt."

Source: Morningstar, *F&C Investments

Source: Morningstar as at 7 August

TOP 10 HOLDINGS as at 31 March 2014

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