We just might be at an inflection point in global equity markets.
Government bond yields keep rising, even for risky high-yield corporate stuff, while a handful of technical measures in the equity markets look a bit wobbly. I sense jitters around AI are intensifying as industry insiders talk up their existential fears, arguably to encourage regulators to give the frontier labs more market power.
Against this backdrop, I think we all need to think long and hard about pushing on with diversifying away from tech and US equities, a daunting task given the huge gains of recent years.
Over the next couple of weeks, I want to explore one potential strategy: revisiting equities that pay a higher dividend yield. This week I’ll start with real estate, specifically real estate investment companies, some of which are investment trusts (REITs).
The popular image of real estate is New York property moguls or vast office skyscrapers in the City but in reality, most investors invest for one of three reasons.
First, property is a real asset class that plays a big role in key trends and themes: think data centres and AI or big-box logistics parks and e-commerce.
Next up, property is also a way of playing the UK economy and its cheap stocks.
Many property investment companies represent decent value, boast big discounts and if you think the UK economy will do a bit better next year (as I do), then property is not a bad bet for capital gains.
The last, most obvious reason is that you buy real assets let out on long leases that produce growing, inflation-proof income, which helps earnings grow over time and in turn, the dividend. Income investors with a more defensive outlook tend to gravitate towards investment trusts or REITs as a result.
All three of these reasons were on display in the last few weeks with the mega story in property: the takeover of Segro by US industrial and logistics giant Prologis.
It was a big, £12bn deal for what is arguably one of the UK’s highest-profile property businesses. Segro was a massive play on the industrial parks and data centre theme, had been steadily growing its earnings – though its dividend yield was a bit meagre – and was regarded as a cheap way to play the UK by a giant US firm.
The Segro deal is just one of many other deals in this space – concurrent with this deal, there’s a takeover battle raging at land regeneration specialist Harworth.
In fact, there have been so many deals that for most UK investors, real estate as a “theme” or niche asset class has been vanishing before our eyes. There used to be dozens of REITs, some self-managed, others run by big fund managers. Now there are just a handful left.
Every month seems to bring a new deal with outfits like LondonMetric, beloved by many wealth managers, playing a prominent role in sector consolidation. What’s also not helped is that, beyond the M&A deals, real estate returns have been tepid at
best and in some cases absolutely terrible.
As bond yields have risen, especially at the 10-year duration, the pain has intensified. It has increased risk-free rates used in valuation models and it has also increasing refinancing costs.
More to the point: if a risk-free gilt will pay over 5pc, why invest in volatile property shares that probably pay similar yields?
Then there’s the constant stream of stories about office sector oversupply, the growing number of sub-standard offices in need of retrofitting to get up to scratch and the general decay of the high street.
I also think there’s a deeper, less-commented-on structural malaise: real estate is losing visibility as an asset class. As the number of investment opportunities steadily falls, real estate is vanishing off many investors’ radars.
Only the very largest funds and businesses can survive this sentiment winter; institutional investors dominate and the sheer variety of underlying asset classes vanishes.
In the US, by contrast, there’s massive choice, with hundreds of funds and a vibrant market among private investors looking for a healthy yield.
The scepticism of many UK investors in the past, by contrast, is not unfounded. Many REITs have been risky and volatile in recent years, nevertheless, I think a strong case can be made for rethinking this increasingly unloved asset class.
Others will disagree but I think bond yields are overshooting at the 10-year and 30-year level, inflation fears are overplayed and in 2027 we’ll see yields – and possibly even interest rates – come down sharply. That will provide a tailwind for real estate.
I also think M&A activity will stay brisk as US investors continue to snap up cheap UK assets and activists stay busy across the sector. More to the point, I’m also quietly confident the UK economy will pick up a tad more momentum in 2027. I take the
Segro deal as validation that the UK is not quite the basket case everyone thinks.
If you share my cautious optimism, what might you look at? My two favourite REITs are Target Healthcare and Grainger.
Both have less-than-exciting yields of around 5.3 to 5.5pc per annum but plenty of upside to grow the yield through strong earnings growth, supported by inflation-proofed long-term lease contracts. Target is the less risky of the two, with a single-digit discount on its shares.
It has low debt levels and a steady book of business and I don’t need to labour the long-term theme of owning modern care homes in an ageing society. In my view, Target could be a classic steady compounder. Grainger is the riskier of the two and is fast emerging as the biggest player in the institutional home rentals market, also known as build-to-rent or BTR.
Given the cost of owning a home in the UK and the increasing regulatory burden on buy-to-let (BTL), I fail to see how we can house more single people (and younger families) in the UK without BTL.
Grainger has much more debt and a much bigger share price discount but is growing its earnings and dividends steadily, and it has some well-known shareholders including Mike Ashley, the Frasers Group founder, and US activist fund manager Saba.
More to the point, with its dividend, you’re paid to wait for that discount to hopefully narrow. I own shares in both Grainger and Target as well as Workspace REIT, where I am a non-executive director.
If these two REITs strike you as a little too focused, then consider the two active funds that I watch closely in this space: TR Property Investment Trust and unit trust TM Gravis UK Listed Property. Both take concentrated bets on key themes and boast very experienced managers, with yields in the 5 to 5.5pc range.
TR Property is managed by Marcus Phayre-Mudge and invests across Europe. It is currently fairly heavily overweight industrial real estate firms, German residential funds and European shopping centres.
The Gravis fund is UK-specific, invests in 21 REITs and businesses, and tends to focus more on a handful of big themes such as digitisation as well as residential. Its biggest holding was Segro and it also owns Target and Grainger among its top five holdings.
