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Buying into a property inflation hedge

A commercial property company’s bond like income stream from inflation-linked leases is likely to prove a winner as inflation spikes in the coming months.
Buying into a property inflation hedge
  • 97.8 per cent of rents demanded have been collected during Covid-19 pandemic.
  • 87 per cent of portfolio leases inflation-linked.
  • Net asset value (NAV) per share up 2.3 per cent to 85.6p in 12 months to 30 June 2021.
  • European Public Real Estate Association earnings per share edges up to 5.55p.
  • Total dividend per share increases 3 per cent to 5.14p.

Investors are justifiably starting to worry about inflation as the impact of spikes in commodity prices is acerbated by supply chain issues, product shortages and tight labour markets. The UK consumer price index is expected to rise above 4 per cent in the coming months, a factor that employees facing a winter squeeze on their disposable income will undoubtedly use in their wage bargaining, especially in industries struggling to recruit staff.

With real interest rates negative and borrowing costs on the floor, then higher inflation not only erodes the real value of debt property owners have secured on their assets, but enables them to pass on inflationary rent increases to tenants, too. Returns can be turbo-charged if lease agreements are subject to inflation-linked reviews.

That’s exactly what Alternative Income Reit's (AIRE:72p) portfolio of 19 commercial freehold and long leasehold fully let properties in non-traditional sectors offers. The portfolio includes care homes, hotels and serviced apartments, student housing, nurseries, car showrooms and petrol stations, and even small power stations.

Around 87 per cent of AIRE’s annual rental income of £7.2m is subject to inflation-linked reviews, and its tenants are of a high quality, hence why almost 98 per cent have paid their rent when demanded since the start of pandemic. Furthermore, AIRE’s bond-like income streams – weighted average unexpired lease term of 17.8 years to break – are likely to be increasingly attractive to investors looking to lock into the 5.94 per cent net initial yield on the £109m portfolio especially as the portfolio is modestly leveraged and the yield easily exceeds the fixed interest of 3.19 per cent on AIRE’s £41m secured loan with Canada Life (expiry in October 2025).

Shareholders received total dividends of 5.14p a share in 12 months to 30 June 2021, and the board is targeting a pay-out of 5.5p a share by September 2022, implying a current dividend yield of 7.1 per cent and a prospective one of 7.6 per cent. Both are well ahead of the 4.8 per cent average dividend yield for Liberum Capital’s UK Commercial property space, another reason why the wider than average 16.5 per cent share price discount to NAV is unwarranted.

Admittedly, the shares are unmoved since my last article (‘Lock into an inflation protected high yield’, 7 May 2021), and are trading at the entry price in my Alpha Report. However, with inflation now picking up, and the portfolio having proved its resilience during the Covid-19 crisis, expect the chunky dividend flow of dividends to be complemented by some decent share price gains. I raise my target price from 80p to 85p. Buy.

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