Ian Cowie: is this investment trust sector a bargain for the brave?

Our columnist points out that current valuations and yields for commercial property investment trusts could offer sufficient compensation for the risks involved.

Half the 350 multinational businesses, that employ a total of 10 million people, who were questioned by estate agents Knight Frank said they plan to cut office space in the next three years.

Working from home (WFH) has turned many folk into TWATs - or workers who go into the office on Tuesdays, Wednesdays and Thursdays - even before artificial intelligence (AI) raised the real risk that WFH might soon mean no work at all.

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On a brighter note, many commercial property investment trust share prices have already plunged to reflect the new reality of empty office blocks, pushing up yields for investors brave enough to buy today. For example, the Association of Investment Companies (AIC) ‘Property UK Commercial’ sector has seen the average ‘total return’ over the last year slump to -25%, pumping up the average dividend distribution to 6.8%.

Bargain-seekers may also be interested to note that shares in this sector are now typically priced 24% lower than their net asset value, which is twice the average discount offered across all investment trusts. The AIC’s ‘Property Europe’ is even cheaper, trading at a typical discount of 38% after a negative ‘return’ of -34% over the last year, yielding 6.2%.

While the latter sector is likely to remain under a dark cloud until peace breaks out in Ukraine, above-average yields closer to home might prove increasingly tempting if inflation remains stubbornly high. For example, if the average ‘Property UK’ dividend yield is sustained - which is not guaranteed - it would double shareholders’ capital in less than 11 years. In ‘Property Europe’, compound interest would take less than 12 years to achieve the same uplift.

Never mind the averages, what about specific investment trusts? All 15 trusts in ‘Property UK’ that have a one-year track record suffered negative returns during that period, according to independent statisticians Morningstar.

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Custodian Property Income REIT Ord (LSE:CREI) led its sector over the last year by keeping losses trivial at 0.1%, after allowing for 5.9% dividend income. Household name tenants including B&Q, Wickes Group (LSE:WIX), Sainsbury (J) (LSE:SBRY) and Homebase continue to pay their rent, despite all the talk of retail migrating online. This helped CREIT keep its discount to NAV tight at 3.4%. Less happily, its five-year return is also trivial at 2.45% and it lacks a 10-year record, having been launched in 2014.

Columbia Threadneedle’s CT Property Trust Ord (LSE:CTPT) ranks second with a loss of 0.9% over the last year, a 4.6% dividend yield and an 11% discount to NAV. Most of the underlying assets are industrial estates with lower profile tenants but they have delivered higher performance over the medium to long-term, with five-year and 10-year total returns of 10% and 99% respectively.

AEW UK REIT (LSE:AEWU) came third with a more substantial one-year loss of 10.2% and a dividend yield of 7.9%. Over five years, the total return is reassuringly positive at 57%, which may explain why its discount to NAV is below 3.3%. AEWU was launched in 2015 and focuses on smaller commercial properties outside London.

For extra spice, Ediston Property (LSE:EPIC) is a special situation because the board of directors have launched a strategic review that could see it either merge with another REIT or sell its portfolio assets and return proceeds to shareholders. The board has expressed a preference for merger but, if the latter option is taken, then that might unlock value in EPIC shares that are currently priced 24% below their NAV and yield 8.2%.

However, one and five-year negative ‘returns’ of -18% and -22% demonstrate the shareholder suffering that is already in the EPIC price. This trust focuses on out-of-town retail estates that enthusiasts argue are benefiting from click-and-collect, online retail and its household name tenants include Marks & Spencer Group (LSE:MKS), Boots and Pets at Home (LSE:PETS).

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Apart from the obvious risk that these trusts might be holding ‘trapped assets’ whose value will never recover and that these shares could become ‘value traps’ where the price of a high income today is low or no capital returns tomorrow, it is important to beware that many yields are also shrinking. The ‘Property UK’ sector has seen dividends fall by an annual average of 2.3% over the last five years.

For the trusts mentioned earlier, the rates of income change are CREIT shrinking by 3.1% per annum; CTPT falling by nearly 4.4%; AEWU marginally positive, rising by 0.01%; and EPIC down 1.9%.

Current valuations and yields in commercial property investment trusts could offer sufficient compensation for the risks involved - plus the potential for substantial rewards if occupancy levels return what used to be regarded as ‘business as usual’.

Unsurprisingly, estate agents tend to emphasise the upside, with Knight Frank’s Lee Elliott insisting: “Better but less space is probably the strap line for larger organisations. It is not the death knell of property markets because what you are seeing is a shortfall of supply, and therefore an increase in rents, for the prime buildings.”

Perhaps peak WFH has already passed, with several big employers - including BlackRock and JPMorgan - insisting their staff return to the office, four or five days a week. Some employees are keen to do so, if only to reduce the risk of being replaced by an AI robot.

Ian Cowie is a freelance contributor and not a direct employee of interactive investor.