Hardman & Co Q&A: Secure Income Real Estate – a positive real return

Hardman & Co

Hardman Secure Income Real Estate is the topic of conversation when Hardman and Co’s Analyst Mike Foster caught up with DirectorsTalk for an exclusive interview.

Q1: What is Hardman Secure Income Real Estate?

A1: Over the past couple of years, we have seen a range of real estate stocks expanding their capital base by raising money and those stocks have been focused on secure income.

So, we’ve found a basket of 17 of these REIT’s, which are UK real estate investment trusts but we focused in on those that have got that sort of visibility of income from assets that have high levels of occupancy and high levels of rent collection.

Q2: Can you remind us what stocks are in that basket?

A2: We’ve got different sectors, there’s a couple that are doctors surgeries investments, there are three that are in distribution warehouses, like logistics, there’s two in care homes and there’s some that have got not such a focus on particular types of assets. All of them have in common that they’ve got pretty long leases and, as I say, very secure income collection.

Q3: And how is it performing?

A3: It’s been a very interesting time, obviously over the past couple of days we’ve seen some very strong balances in some of the more volatile real estate shares but over the past two years that this basket has been in existence, there’s been a positive real return.

So, the capital has very slightly fallen in value, by about 5%, but there’s been the dividends cumulatively received and that’s meant that if an investor had invested £100 at the start of 2019, he would now have gained about 5%. Now, that compares to the broader UK REIT’s so that’s all the UK real estate stocks, the more volatile ones like British Land and Landsec, they have bounced very strongly in the last couple of days but even so the returns from them are slightly negative. If you rewind to a couple of days ago, then they had seen 25% falls.

So, I think that the point to be made is that there’s firstly, a lot less volatility in these secure income REIT’s which you would expect but also that they are making positive returns to investors over a period that’s been pretty difficult for all real estate stocks.

Q4: So, are you saying that the dividends are more important than assets?

A4: Yes, clearly for an investor, both are important, you want to see a preservation of capital and growing income but over time, most of the returns from investments, whether it’s real estate stocks or other stocks, do actually come from retained income. It’s the dividend prospects, after all, that drive the value of the capital even if you look at the value of the assets themselves, it’s the rent’s income potential that drives the asset valuation.

So, in these difficult times, we’ve seen the value of offices and shopping centres fall because of the rents so it’s the income either from the assets directly or from the dividends that does drive the whole thing.

In terms of the actual returns, we’ve seen that again in the past couple of years, the secure basket has made money for investors, in an absolute sense, because of that income that they’d been receiving.

Q5: Now we know market-wide dividends are falling so it’s impressive that the basket’s generally rising. What about the share prices though?

A5: So, dividends are indeed rising in the basket, the share prices, if you look at the 17 stocks, the share prices on those 17 stocks have outperformed the broader real estate stocks in 9 of the past 12 months. If you look at the share prices of the 17 over the past year, well over half – actually we calculate it’s 10 out of 17 – have seen share prices increase in the past year.

Q6: So, why would or should investors be interested if prices have fallen in 2020?

A6: Overall the index has seen a small fall in 2020 but not much.

The point of the matter is that from here, we’ve got dividends on average that are yielding nearly 5% in these stocks and they’re trading at around about NAV. They have shown that in difficult times, apart from the very volatile month of March, the capital, the share prices, have been pretty secure.

So, we think that there is an ongoing demand for the logistics, we mentioned that there’s three of the stocks that are in warehouses/logistics, the trends towards internet shopping isn’t going to go away. The supply of these logistics assets is actually dwindling for reasons we haven’t got time to go into, but they are actually seeing more and more alternative uses.

In terms of a lot of the other stocks, quite a lot of the rents come from government payments, either of housing benefits or to doctor’s surgeries so that should be a very secure income stream and a lot of those income streams are yielding 4/5%.

I’ve been talking about the broader real estate market, if you look at the broader, the FTSE100 shares across the market, we’ve seen their dividends and the real pressure and they might bounce back a little bit, but the economic hit from the past 10 months is going to be lingering for quite a while.

So, I think that the dividends stream from the broader real estate stocks and from the broader market for equities in the UK and internationally, it will be a bit uncertain. Whereas most of the income stream in the secure income basket, as I say comes, either from the government or it comes from areas where there is much stronger demand and there is supply.

Q7: As always there are risks, what can you tell me about them?

A7: Well, in a way, investors are trying to make absolute money but they are also looking to make money relative to other things and we’ve seen over the past two or three days with the very good news about the potential vaccine that, although the secure income basket shares  have gone up, they’ve gone up by perhaps 2/3/4%, whereas shares like British Land have gone up by 15/20%.

So, if you’re looking for a bounce, maybe we’ve seen the bounce, but certainly these shares if we see sustained confidence about the economy growing, maybe they will underperform. We actually think that they won’t because of the valuation and the strong dividend yields but there is always that risk that these are safer shares so if you want to go for risky things, these won’t deliver that.

The risks also are that in any real estate, you can have a change in trends, as I say, most of these have very long leases that they’ve invested in but sometimes the tenant covenant, the quality and the strengths of the tenant, will be less than you’d expected and they might find that the tenants have difficulties in paying the rent and need to get other tenants coming in for those assets.

That has happened in a couple of small cases in the basket and, so far, actually, new tenants have been found to replace the old ones on the same or better terms for the leases so that was an excellent outcome in a potentially slightly difficult situation. In the future, we’ll see there are risks that you might not be able to find a tenant to replace it.

Nonetheless, these are safer shares in terms of the income stream, the quality of the tenant than many in the market.

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