Standard Life Investments


Rents in the retail sector are expected to come under pressure, which has led Will Fulton, manager of the UK Commercial Property Trust (UKCPT), to reposition the company, reducing retail premises and tilting towards industrial and logistics warehouse property, which he believes has greater growth prospects.

'Our forecasts and my own experience show there will be pressure on rents in the retail sector,' he says. 'They have done very well, particularly in Central London, but continued growth looks unlikely given that businesses aren't expanding as fast and economic growth is slowing for this market.'

Fulton started to reduce the company's exposure to retail property shortly after he took it over two years ago. The subsequent result of the EU referendum has increased the likelihood of a slowdown in the sector given the anticipated price inflation (higher sterling costs for retailers) in an environment of low wage growth.

UK retail property may suffer from reduced demand and uncertainty in the wider economy, while some international retailers using the UK as a bridgehead to Europe may be deterred – at least in the short term.

Fulton believes that industrial property offers greater rental growth potential. 'Industrials are a really exciting market at the moment,' he said. 'There has been so little new supply built over the last ten years. At the same time, demand is growing due to structural changes in the retail marketplace and that is flowing through to real rental growth, which has benefited our performance.'

Growth in e-commerce, for example, has led to higher demand for warehouses and distribution units.  Around 45% of the company's exposure to industrials is in 'big box' logistics warehouses.

Buys and sells

Fulton has bought and sold property worth more than £400 million since he took over management of the investment company in April 2015. In his first year at the helm, he transacted £308 million of stock and in his second year £99 million.

The effect of this has been to decrease UKCPT's weighting to the retail sector from 45% to 38% at the end of March, giving it a marginally underweight position relative to its benchmark, and increase its weighting to industrials from 26% to 33%, a 12% overweight compared to the benchmark. London offices have also been sold off, ahead of their valuations, as the outlook for Central London is less positive. Most recently, 13 Great Marlborough Street, Soho, sold at a yield of 3.3%. Returns from this sector were slowing pre-referendum but the result has brought additional uncertainty and downside risk with businesses here most exposed to potential regulatory restrictions on European trade reducing demand for office space.

Retail assets sold include a block of properties on London's Kensington High Street to an overseas family office due to concerns over how the extension of Westfield London shopping centre would impact future rental growth, and Weston-Super-Mare's Sovereign Centre on the grounds that it needed significant capital investment without any additional return.

Sale proceeds have been reinvested in industrials that provide a sustainable income with rental growth potential. Purchases include Ventura Park, a 35-acre industrial estate located just off the M25 at Radlett, bought for £67 million and a net initial yield of 6% with rental growth potential. Tenants include DHL, Kelly's self-storage, EE and Warner Brothers Studios.

The company also recently invested in a £22.8 million forward-funding commitment to acquire an industrial distribution unit in Burton upon Trent. Due to complete in July 2017, the unit was fully pre-let and is set to generate a yield on cost of 5.8%.

Depth of resource

UKCPT has £71 million left in cash available for investment. Fulton became a member of the Royal Institution of Chartered Surveyors in 1990 and three other surveyors dedicate 100% of their time to the company. They are always on the lookout for opportunities.

'It's very much a people business and with almost 30 years' experience [in property investment], I know a lot of people and that helps,' said Fulton. 'We see almost all deals – both on and off the market. Fulton and his team are supported by Standard Life Investments' extensive team of property professionals so UKCPT has tremendous depth of resource to research and pick up opportunities.'

One area to which Fulton is keen to increase exposure is long leases with index-linked increases. The Burton upon Trent deal is a good example of this; the tenant has committed to a 15-year lease with annual inflation-linked rent increases of between 1% and 3%.

The company's focus on quality enables it to attract the best tenants and boast one of the lowest void rates in the sector – 4.1% versus a sector average of 6.8%. This helps to support a robust annual dividend yield that currently stands at 4.1%.

Attractive proposition

Stockbroker Winterfloods is positive on the changes Fulton has made and believes they have made the company a 'more attractive proposition'.

'Recent performance is also encouraging and, while the dividend is not entirely covered, the company has significant financial flexibility and we would anticipate it reaching full cover as available cash is deployed,' it said in a recent research note.

'The largely prime portfolio and very conservative balance sheet leaves it well positioned to weather more difficult market conditions and its size means that its shares offer good liquidity in the secondary market.'