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Paying a premium for property income

Richard Kirby tells Stephen Wilmot why his retail exposure doesn't keep him awake at night.
September 6, 2011

Take the Oxford Street exit of Bond Street Tube station and you can spot, on the opposite side of the road, a narrow alleyway called Gees Court. Slip inside and you enter a traffic-free oasis of shops and restaurants called St Christopher's Place. Café tables sprawl across the pavement and shoppers meander in and out of pocket-sized boutiques occupied by the likes of Mulberry, Jigsaw and T.M.Lewin.

IC TIP: Hold

Investors can own a tiny slice of St Christopher's Place by buying shares in its owner, F&C Commercial Property (FCPT). Valued at £154m at the end of March, the estate is by far the investment trust's largest asset and one of its most resilient performers. Can it last? I visited the trust's lead fund manager Richard Kirby at F&C Reit - who is based a stone's throw away on Wigmore St - just as the property industry is reeling from bankruptcy declarations by major tenants Habitat, Jane Norman and Homeform. Even landlords that do not let space directly to these brands will be affected, as vacancies depress market rents, reducing the value of the portfolio and sapping income when leases expire.

Not us

Yet the manager thinks FCPT is largely insulated from the retail industry's problems. "Yes, I am concerned about the structural issues that are threatening the high street," he tells me. "But most of my retail is in London at St Christopher's Place, and I don't own any shopping centres. My retail exposure doesn't keep me awake at night."

Investors seem to share his relaxed stance. FCPT trades at an 8 per cent premium to the March value of its net assets, for two main reasons. First, with a portfolio of top-quality assets and little debt, the investment trust is considered a safe bet by private-client stock brokers. They assume its skew towards London will protect it from vacancies associated with public sector cutbacks and squeezed disposable incomes.

Second, FCPT boasts an eye-catching dividend yield of 5.7 per cent, which is paid in monthly instalments. With no return from cash and little confidence in the economic recovery, investors have been happy to pay top dollar for an asset-backed portfolio that has a long track record of paying out income. Unlike many of its peers, FCPT did not cut its dividend during the 2007-09 property crash.

So just as institutional investors have since 2009 seized on prime London properties as a reliable source of income in a low-yielding world, retail investors have targeted prime property funds. FCPT is one of the two giants among the offshore property investment trusts set up mid last decade. The other - UK Commercial Property, which narrowly failed to push through a merger with FCPT last year - also trades on a premium.

Richard Kirby

The value question

A premium is immaterial as long as investors can get out at the same level. But if it slips, it could easily wipe out a year's worth of dividends. And the hit would be compounded if the flight to quality that has dominated property performance over the past two years ends, causing FCPT's prime assets to lose something of their lustre. Admittedly, with no sign of interest rate rises or a resurgence in economic confidence, that looks unlikely in the short term.

When I ask whether FCPT's shares offer value at today's level, Mr Kirby is reluctant to answer. "We have purchasing costs of 5.8 per cent when we buy a property, so in a stable market we should trade at a premium," he points out.

Ultimately, whether or not the shares offer value today depends on the future performance of the portfolio. Mr Kirby's track record through the financial crisis is reassuring. Net asset value at the end of March was 97p - exactly the same as at launch in January 2005, a commendable result compared to the value destruction wreaked by almost any other listed property company. He says the decision that has had the most impact on performance was not to buy anything in 2006 or 2007 and to sell assets and reduce gearing in 2007-08. By the horrible fourth quarter of 2008, FCPT had gearing of just 10 per cent. His decision to start buying again in mid-2009 also proved the correct call.

Richard Kirby
Richard Kirby is director of property funds at F&C Reit. In addition to managing the F&C Commercial Property Trust, his responsibilities include advising on and implementing portfolio strategy, sales, acquisitions, asset enhancement and management. He has been a fund manager since 1995, initially with responsibility for Friends Provident unitised funds and then for the retail assets across client portfolios. Prior to joining F&C Reit in 1990, Richard gained experience in professional practice and at an investment agency.

Another advantage of FCPT is its development pipeline, which will help drive up the value of the portfolio. The trust is building an office block on Great Pulteney Street in London's Soho, due for completion in October. Mr Kirby is optimistic about the rental prospects. "It's one of the very few completions in the West End this year. We're holding off marketing at the moment, and I'm sure the rents will surprise on the upside," he enthuses.

But buying FCPT does come with appreciable risks. First, the average lease length on the portfolio is short, with a spike in lease expiries in 2015. Second - and more pertinently for shareholders - FCPT's dividends are not covered by rental income. That means the fund's cash reserves are routinely used to top up the yield, leaving no scope for dividend growth. "Investors would prefer to see cover improve than an increase in dividends," Mr Kirby admits.

That improvement in cover will come gradually as Mr Kirby makes acquisitions, which is perfectly possible given the low current level of net gearing, at 20 per cent. The Soho development will also help. And the manager has plans to drive up rents further at St Christopher's Place by improving the tenant mix and working with the council on upgrading the fabric of the street. "There are some retailers who you'd expect to be there who aren't there," he says.