Jun
2017
Didn’t sell in May? There could be an alternative for investors seeking income
DIY Investor
21 June 2017
Perhaps we should, after all, 
‘…. The summer’s really here and it’s time to come out. Time to discover what fun is about….’1
Philip Gilbert
Head of Fixed Income
Really, or maybe just hold your position; last year from 1 May 2016, the value of the FTSE 100 rose by 11.5%.
Okay, in 2015, you would have lost about the same amount, and including the previous three years you would have just about broken even (on share prices alone). But, you would have missed several ex-dividend dates, potentially unnecessary trading costs, and trigger capital gains when you don’t want them.
But what of 2017? Well, UK 2-year gilts yield c. 0.12% – while UK stocks yield an average dividend of c. 3.7%. This yield differential between stocks and bonds goes some of the way to explaining why the FTSE has hit a new all-time high at 7523 this morning (25th May). Despite this, in terms of market activity daily traded volume have fallen by as much as 50% in recent days. Does this tell us prices are too high? Is it because bond yields are so low?
Bond yields are low because of QE distortion artificially upping bond prices and keeping yields low.
Markets should be at all-time highs because of expectations of future growth, rising profits, and a strong feeling that the global economy is headed higher, shouldn’t they? A few stats in recent blogs make interesting reading:
- In the US, most of the recent gains have been concentrated in a very small number of the mega-cap tech stocks, e.g. Apple, Google, Facebook and Amazon
- Close to 30% of the S&P500 stocks are 20% down from 1 year highs.
- The VIX volatility index is at its lowest level in 10-years, although it has begun to move upwards
If markets are close to the top, there should be buying opportunity later this year. Remember Warren Buffet, ‘Be fearful when others are greedy and greedy when others are fearful’.
‘Be fearful when others are greedy and greedy when others are fearful’
Any other black swans out there? Well there is the global geo-political situation such as North Korea, ISIS et al, the unpredictable Trump, and Brexit, and of course inflation; UK CPI rose to 2.7% in April, up from 2.3% in March and 0.3% a year ago, reaching levels last seen in September 2013.
Of course, for investors seeking yield (income) this isn’t good news, adding to the pain inflicted by falling asset yields: so where do investors look for yield?
If we discount equities and bonds, of the alternatives commodities don’t provide yield, which leaves the UK investors perennial favourite, property.
Property investing for income
Property typically splits into two segments, commercial and residential, however I would like to introduce a third; housing associations and specifically, social housing:
Social housing is residential property let at relatively low rents on a secure basis to tenants who are most in need with their housing costs. The main providers are local authorities and not-for-profit organisations such as Housing Associations (‘HAs’).
Social housing accounts for almost 20% of all UK housing stock, the full open-market value of this is estimated at between £1 and £1.2 trillion
Prior to 1979, social homes averaged 40% to 50% of total housing stock, which fell 24% in the 1980’s.
We have managed to build only 58,000 new properties in the last two financial years whilst there are currently c. 4.5m people (1.24m households) on local authority housing waiting lists; this figure is expected to rise by a further 1 million, by 2021.
The shortage of homes has led to a growing demand for private rented accommodation throughout the UK; currently, there are around 4m homes privately rented in England accounting for 18% of all households – the sector has doubled since 1989 and now has more households than in social housing.
Rents are maintained at affordable levels for low income households; today they are set at 80% of private sector rents – across the social housing sector 60% of the of the rent roll is paid by the Government via Housing benefit with 40% paid directly by the tenant.
From an investor’s perspective, social housing has many positive attributes:
- leases are long, up to 50-years, and linked to CPI
- rental voids are covered by the HA
- virtually 100% occupancy levels with low bad debts – c2.5% of gross rent per annum, and less than 1%. in London and the SE
- implicit support from local government; the sector has never suffered a credit default despite around £60bn having been lent over the past 30 years by banks and building societies.
- a regulated framework provided by the Homes and Communities Agency (‘HCA’)
- properties are professionally managed by a Registered Provider (‘RP’), regulated by the HCA, who service all management and maintenance obligations.
RPs have sought to address the shortage of homes by reducing costs, enabling a drive to build more homes, this was also partly necessitated by a 1% reduction in annual rent and cuts to grant funding.
In Europe, institutions have supported the development of the sector, but the UK has used a combination of Government grants (c£60bn) and senior bank debt/building societies (c£65bn).
Local authorities cannot borrow, so to overcome this around 1m social properties were transferred from local authorities to HAs, who can borrow, at no effective cost; whilst the Government has progressively reduced capital subsidies to HAs, many of them have a substantial base of housing assets, held on their balance sheet at cost or very low levels.
The sector has an excellent credit record, the few RP that have encountered financial problems have been rescued by stronger associations, while no private lender has ever lost any money – there has never been a credit loss across the social housing spectrum.
‘a bricks and mortar investment opportunity, in a highly-regulated sector, supported by central / local government’
Until the financial crisis, the sector was well-supported by banks, building societies and specialist lenders, while some borrowers issued corporate bonds. In general, lenders were attracted by the inflation linked rents with income effectively paid by government via housing benefits and a strong regulator.
In summary, we have a bricks and mortar investment opportunity, in a highly-regulated sector, supported by central / local government; assets (the properties) are professionally managed, and let on long-term leases linked to CPI.
Better still, tenant demand outstrips limited supply, with 4.5m people on social housing waiting lists in England and Wales and just 58,000 properties built in the last two years.
This gives investors the opportunity to access long-dated ‘real’ income that could be described as from a supra-national provider. Small wonder that some of the biggest investors in the sector are pension managers such as L&G and M&G, who use the sector as a way of matching their long-term pension liabilities. For example:
- M&G Real Estate is provided £19m for the development of 189 residential homes for a development company owned by Welsh housing association, RCT Homes.
- Legal & General (L&G) announced it has secured a portfolio of over 4,000 housing units, let to Places for People Homes on a new 50 year lease, as it continues to grow its role in supporting the UK’s housing needs.
So far, hopefully interesting, but how do you access the sector? There are ORB listed bonds issued by HAs such as Places for People, and Alpha to Dominion, or the REIT issued by Civitas Social Housing.
To my mind none quite hit the spot, what I would like is long-term CPI linked coupons/dividends.
There is the Places for People 1% index-linked bond but the real value of that is paid at maturity as the redemption is also linked to inflation.
Civitas have a target dividend yield of 5% p.a., which it expects to increase broadly in line with inflation.
Both, to my mind are “close but no cigar”. Still, a sector worth watching……….
1 – The Undertones – Here Comes the Summer
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