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14 June 2022

Property and its Long-Term Defensive Qualities

It is undeniable that the cost-of-living crisis in the UK is worsening, with April seeing inflation hit its highest level in almost 40 years. This does not mean, however, that investors are doomed. While one would hope that rising prices aren’t a permanent issue meaning that the future is still bright for long-term investors, there are ways to reduce exposure to risk while maintaining relatively strong returns throughout the course. Inflation does not necessarily hurt all businesses and a particular example of this is Real Estate Investment Trusts (REITs). These are companies that own/operate properties such as warehouses, healthcare infrastructure, office buildings and retail outlets which pay dividends via the collection of rents.
 
While properties for commercial use are often closely linked to demand-led inflation in the economy, they still carry a degree of economic risk. Retail, for example, has been a victim of the economic shutdown during the COVID-19 pandemic. More often, however, REITs tend to perform well in inflationary environments as the overall price environment means that the factors of production – land, labour, and materials – cost more, which can raise the economic threshold for new development and, therefore, increase property values. This, in turn, may restrict new supply, supporting higher occupancies while giving landlords the potential to raise rents. The legal structure of REITs means that 90% of the tax-exempt profit must be paid to shareholders, passing the income from higher rents on to them. With many rent leases also being tied to inflation, this may serve to bolster rent prices even further, increasing values and supporting REIT dividend growth.
 
One such REIT that is well suited to withstanding the woes of economic uncertainty is Home REIT: a trust dedicated to fighting homelessness through funding the acquisition of new, high-quality accommodation. The fund provides a high degree of income security due to its government-sourced funding in which past performance has shown that 100% of rent has been collected since inception. Sadly, homelessness in the UK is on the rise with little sign of improvement, increasing 33% on average from 2016 to 2019 with a major cause being increasing house prices. Despite the pandemic, house prices are continually hitting all-time highs, with rental costs rising in tandem. As a result, it is unlikely that homelessness will fall in the short/medium-term which will invariably increase demand for the accommodation provided by Home REIT. These circumstances in turn provide investors with access to a collective that is both reliable and delivers a critical social impact. The 5.5% forecast annual yield, which management is confident they can easily pay, coupled with government backing, gives a certain level of security that equity income funds cannot offer in the current inflationary climate.
 
Primary Health Properties (PHP) is another example of a REIT with little sensitivity to the economic climate. It invests in healthcare real estate let on long-term leases, where 90% of cash flows are either directly or indirectly government backed. The primary healthcare sector is less cyclical than other real estate sectors because the need for it isn’t going away and is arguably greater in this post-pandemic setting. With an ageing population and, therefore, more instances of chronic illness, healthcare demand matched with the demand for PHP is set to increase. The sector is relatively price inelastic where in the rampant economic uncertainty of 2020, PHP’s dividend per share increased by 5.4% while the UK’s blue-chip index dividend payments fell by 20%. PHP has strong structural growth potential given the demand for modern medical facilities making it a suitable area to invest in for inflation protection.
 
Although REITs are an opportune investment in an inflationary environment, like all investments they are not immune to systemic risk. Additionally, with the Bank of England raising interest rates, Treasury securities may become more attractive which could draw funds away from REITs and lower their share price. That said, the government-backed nature of the named REITs and the high yields that they produce are likely to overcome any rate rise fears in which the base rate currently is too low to have ample effect. REITs, therefore, act as a strong diversifying factor to investment portfolios acting as a defender to inflation over the long-term.
 
This article was taken from the February 2022 issue of Market Insight. To subscribe to our investment publications, please visit www.redmayne.co.uk/publications.
 
Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned. The value of investments and any income derived from them may go down as well as up and you could get back less than you invested.
 
Property and its Long-Term Defensive Qualities
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