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John Spiers: what put us off popular PRS Reit

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John Spiers: what put us off popular PRS Reit

It’s been an impressive year already for capital raising by investment trusts with over £7 billion subscribed, £2.5 billion into new trusts. In the main money has flowed to trusts with alternative strategies, typically with an income focus.

It’s still tough to raise capital for long-only equity trusts because most of these trade on discounts to net asset value. The forthcoming launch of The People’s Trust will be a big test of appetite in this space. I am hoping that it does well as I entirely support Daniel Godfrey’s focus on long-term performance.

Questionable prospects

The PRS REIT (PRS) raised an impressive £250 million (and was twice oversubscribed) to acquire brand new homes for the private rental sector. Residential property has historically been a strong performing asset class and the shares projected a dividend yield of 6% gross, so I can see why many found this real estate investment trust offer attractive.

However, historic returns have been driven mainly by capital growth and the third paragraph of the Investment Highlights section of the prospectus (on page 54) commendably made it clear that this trend is most unlikely to continue.

The average house in the UK now costs almost eight times average earnings (double the level of 25 years ago) and the UK has the worst affordability for housing in the 36 countries in the OECD (Organisation for Economic Cooperation and Development). To expect this trend of capital appreciation to continue when mortgage rates can only move upwards requires tremendous confidence.

However, even if prices just remain level then 6% income could be enough to justify investment. The first batch of properties are being bought on an expected gross yield of about 6%. However, the combination of some voids, maintenance costs and agent fees will reduce that to around 5%. Then there is a management fee on the trust of 1% (+ VAT which won’t be recoverable). Getting the yield to investors back up to 6% requires the magic of gearing at a low rate of interest but that increases the risks.

The properties will all be brand new, mainly situated in the north of England. They will be developed by Sigma Capital (SISGM) – an AIM-quoted developer – who will also be the managers, so the inevitable conflicts of interest worry me. I would also be a little concerned that if most of a development is sold for rental occupation it could acquire a reputation as a ‘rental ghetto’. Tenants tend to be less keen on keeping their properties looking neat and tidy than owner occupiers. That could be a drag on long-term rental growth.

As we’ve seen in central London recently, property prices can fall as well as rise so I’ll be waiting for a more realistic view on growth prospects to become established before I am tempted by PRS.

If I wanted an income generating trust in that sector I’d prefer Civitas (CSH), which also raised £250 million, this time in November, to invest in social housing. I think it offers a more secure income stream because its properties will be leased on a long-term basis, mainly to local authorities and housing associations, with inflation linked rents.

Got behind Greencoat

A recent launch that we did like was Greencoat Renewables (GRPG). Greencoat, manager of Greencoat UK Wind (UKW), has excellent experience in this sector and this brand new investment company has acquired wind farms in Ireland, a location with one of the most reliable breezes in the world!

The fund raised €270 million (£240 million) at its flotation in Dublin and London this month. It will use a fair degree of gearing to supplement returns but we consider that to be reasonable due to minimal downside risk in terms of pricing due to the government’s renewables incentive scheme. A 6% yield is projected which should increase with Irish inflation.

Inevitably all revenues and dividends are denominated in euros which adds to the risks for a sterling investor.

John Spiers is chief executive officer of London-based wealth manager EQ Investors.

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