High yield heroes

If you're an investor who requires income, it's hard to ignore these kinds of numbers, and that's why most of the companies profiled below are on our buy list. But - to get the health warnings out of the way early - the high yields on offer do reflect some sizable risks.

First, there's little sign of dividend growth in some companies; conditions in the regional retail and office markets could hardly be less conducive to raising rents. Second, some are straining under weighty debt burdens. Commercial property values fell nearly 45 per cent in the 2007-09 crash, and in most cases haven't budged since (the much-hyped bounce only happened to prime assets). The imperative to rebase leverage against post-crash valuations will constrain some landlords' ability to increase dividends, should any extra cash flow come through.

Healthy returns

That said, some of these companies look in remarkably good shape. One niche we particularly like is doctors' surgeries, which despite the government's reforms to the NHS look a safe haven of modest rental growth. And some companies that operate in the moribund mainstream markets are small and nimble enough to offer more than raw market beta.

For example, those that aren't already crippled by borrowings have taken advantage of the extraordinarily low cost of debt to buy high-yielding property - an arbitrage that immediately boosts income. Mucklow bought five assets last year with a rental income yield of 9 per cent, against a marginal cost of debt of just 3 per cent. Pre-tax profits consequently rose 8 per cent despite a flat market.

Mucklow and the healthcare players trade at tight discounts to net asset value, reflecting their defensive qualities. Others trade at discounts that can only be described as distressed. Yet what all these companies have in common is asset-backed income. Sub-prime property is out of favour with investors, who simply can't raise the debt to buy it, and valuations will probably continue to sag next year. But Britain is not over-developed, and as long as businesses still require offices and shops these companies' portfolios will be in need. Property is going through a cyclical downturn, not an existential crisis like HMV - and that's an opportunity for value-oriented stock pickers.

Nine, high-yielding, bite-sized property companies

CLS Holdings owns a portfolio of offices and is run opportunistically by a canny Swede called Sten Mortstedt, who also owns over 60 per cent of the stock. Unlike the big Reits, he isn’t afraid of making grand calls on the market, and sold £750m of property in 2006-08. Now he is buying again - including CLS’s own stock, which looks very cheap indeed on a 47 per cent discount to adjusted NAV. But CLS isn’t a Reit and for tax reasons Mr Mortstedt doesn’t pay dividends, instead returning cash via tender-offer buy-backs (currently worth the equivalent of a 4.5 per cent dividend yield).

Redefine is the highest-yielding stock in this sub-sector. That reflects financing risk rather than portfolio risk - the company’s collection of government-let offices and the odd shopping centre look solid. Yet Redefine’s South African parent has agreed to underwrite a rights issue, so we don’t think the risk is as great as the reward on offer.

Primary Health Properties and MedicX both own doctors’ surgeries let to the NHS. This is an exceptionally stable business, with no portfolio voids and virtually no letting risk. Both companies have managed to extract 2-3 per cent rental growth from the district commissioners even as the NHS has tightened its belt. On the bear side, MedicX pays its dividends out of capital growth as well as cash, constraining NAV growth. Primary Health’s dividends are less generous and it has higher debt levels, which will act as a brake on earnings growth.

Mucklow is a family-owned and -run property business, which operates in the industrial-estate sector in the West Midlands. Like CLS, it saw the crisis coming and paid down debt by selling a slug of investment property at the top of the market. Even after a couple of years of acquisitions its loan-to-value ratio is only 36 per cent.

Picton is a diversified fund with a wide range of properties. Like Redefine, the high yield reflects refinancing risk - all its debt expires in 2013.

Town Centre Securities is yet another small, prudently run family property firm. Based in Leeds, it mainly owns retail assets in the North. That probably explains the gaping discount to NAV. But the dividend yield is highly attractive and, even if it doesn’t grow for a year or so, it probably won’t be cut - with a large family shareholding reliant on the income, Town Centre Securities didn’t cut its payout in the crisis.

McKay Securities owns secondary offices in the South of England. Don’t expect growth, but the dividends are attractive, and there’s upside in the share price if McKay sorts its debts and interest-rate swaps out.

Local Shopping REIT owns corner shops and small cafes across the UK. There’s little rental growth in that market, but rents won’t plummet either - demand for ‘convenience’ retail is pretty stable. And it should achieve modest income growth by expanding its fee income from joint ventures