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Why we buy small properties for an 8% yield

Brexit and the threat of an exodus of City workers have cast a dark cloud over the London commercial property market, but investment opportunities remain good outside the capital, according to Alex Short of AEW UK Reit (AEWU).

In this video interview Short explains how it is still possible to generate attractive income and capital returns from small but high quality properties in the provinces.

She highlights how some smaller industrial units are trading at 25-year lows when adjusted for inflation and that she has begun to see investment opportunities in the battered high street, retail sector.

Launched two years ago, AEWU is the highest yielding property fund in the AIC Property Direct - UK sector. The company pays quarterly dividends of 8p a year, which Short says are covered by earnings. Its average loan to value is 20% but this may raise to 25%.

The real estate investment trust is looking to raise up to £60 million from investors to expand its £131 million portfolio. New shares are being offered at 100.5p, a 1% discount to the closing price on 28 September before the fund raising was announced. The subscription offer to new investors closes on 18 October and a placing to existing investors ends the next day.

AEWU shares stand at 101.2p today, a 6.9% premium to their estimated net asset value of 94.9p, according to Morningstar data.

Can’t watch now? Read the transcript

Gavin Lumsden: Hello with me today is Alex Short, manager of the AEW UK real estate investment trust. Alex, thanks very much for coming in. Now the trust launched two years ago, you’ve invested about £140 million in smaller, higher yielding properties. I’m just wondering, there still seems to be a Brexit cloud hanging over the economy and over commercial property, notwithstanding there has been a rebound over the past year. Could I start by asking you why is now a good time to be investing in commercial property?

Alex Short: So for us it’s a very specific part of the property market that we’re investing in. so we’re excluding London which we think looks quite fully priced and we think perhaps has suffered the Brexit effect more than other parts of the market. So very specifically regional properties and smaller than average properties too, we think there is a real pricing advantage there.

GL: So what is so attractive about smaller lot sizes? You’re focusing on properties of £2 million up to £15 million I understand.

AS: Yes. Well they’re still not fully priced compared to their peaks back in 2006, obviously before the very big property downturn then. And there’s really quite a significant yield advantage in small lot sizes compared to large lot sizes. Typically, they’re much less heavily competed over and that’s reflected in the prices that we need to pay.

GL: Ok. And why is that? Is that because smaller companies aren’t doing as well as the larger companies? What’s it saying about the UK economy?

AS: Well the types of property we buy, some of the very large fund management houses would consider them to be quite hard work to look after. And when they have some real success on it actually in terms of their overall portfolio performance, it’s a very small part of their performance. They tend to focus on big lot sizes where they can get big results, whereas for us, although we all come from a very long institutional property background with a track record of working together in excess of 20 years, we can focus on these smaller properties and add an awful lot of value.

GL: Ok now in terms of investors, what is the main thing they’re getting out of this activity? It seems to be income. You pay, you’re targeting dividends of 8p per year. And you’re yielding around 8% currently, which is the highest in your sector.

AS: Yes.

GL: So is it all about income?

AS: Typically we tend to buy properties yielding 8%, perhaps sometimes slightly higher than 8%. And as you say we pay an 8p dividend. That’s a covered dividend and I think that’s very attractive for investors.

GL: Where are you looking? Where are these pipeline of opportunities that you see?

AS: All around the UK, so Belfast was particularly successful. We bought that property for £7 million and two years later we sold it for just over £11 million.

GL: So there is capital growth here as well?

AS: Yeh, there can be capital growth but we tend to guide our investors to look to asset management for capital growth rather than necessarily yield growth at this stage. Because obviously it’s very difficult to be certain what’s going to happen in the wider economy. But yes absolutely, through doing deals with these tenants, sometimes changing the structure in the buildings, absolutely there is money to be made on the capital side as well.

GL: Now currently about 40% of the portfolio is invested in industrial assets, industrial properties. What exactly are you referring to when you say industrial?

AS: So it’s the good quality, second-hand industrial space. So not the big shiny distribution units that you see being occupied perhaps by the likes of Amazon and John Lewis. The good quality working stock, sometimes manufacturing, sometimes storage. For us, always it’s well located, always with a good infrastructure link for it. Typically buying off capital values per square foot, lower than the cost of building these units. And rental values for tenants often around 3£ or $4 a foot, so in real terms industrial rents as low as they’ve been for 25 years.

GL: That sounds very attractive but you’ve got 40% of the fund in that area already. Will you be investing more or are you looking at other sectors?

AS: We’ll probably go slightly higher in our industrial weighting perhaps up to 50%. But we do manage this as a diversified portfolio so you’ll see other sectors too. So we’ll have industrial as our biggest sector but also some exposure to retail, we’re finding some very interesting retail, high street assets which have been incredibly heavily discounted now.

GL: The retail sector is having a terrible time for one reason and another but it’s throwing up investment opportunities?

AS: It is, so selectively. So we focus on the big centres, the top 50 sectors and actually the one I’m in the process of buying a retail property at the moment, that’s a top 25 sector. So we tend to be very, very hard on these properties now and when we analyse them at purchase, reducing the rental values in our appraisal, moving the yield out in our appraisal but yes, I would say they’ve been discounted so heavily now that we are finding a few interesting opportunities.

GL: OK Alex, thanks very much.

AS: Thank you.



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