WITH the UK housing market in the doldrums, could investors do better by turning to European property markets, or are these too in meltdown?
While European property securities have not been immune to the sell-off in worldwide markets, they have seen relatively better performance than the market as a whole.
Property stocks distinguish themselves in several ways:
&149 as high dividend payers;
&149 by the visibility of earnings;
• by the depth and breadth of investable stocks on offer.
When considering property investments across Europe, one can be selective on a geographic basis, avoiding pockets of economic distress, such as Spain, and focusing on areas of greater resilience, such as the Netherlands.
There is also the matter of choosing to invest in either a specialist company or in a company with a portfolio balanced between sectors. Franco-Dutch company Unibail-Rodamco, for example, focuses on retail by owning large, dominant shopping centres principally in France and the Netherlands. Dutch company Wereld, on the other hand, owns a mix of retail, office and industrial properties across Europe as a whole.
However, a general theme across equity markets is balance sheet strength. This has become a key performance determinant while global credit markets remain constricted. Companies with short-term refinancing and those which are highly leveraged are lagging across equity markets.
Property company earnings are generally visible and can be stable in comparison with other equities. This is because their income is guaranteed in the form of the leases to the tenants in the buildings they own and manage.
Property stocks can be selected for those with the healthiest occupancy rates and the longest unexpired lease terms. At the same time, companies with a development bias can be avoided where future earnings are dependent on letting new schemes and are therefore more risky.
Effectively, boring is best in this market. Racier property stocks based on capital appreciation and leverage are definitely not in vogue.
Although property values remain under pressure, valuation declines have been priced into property shares for some time. Property shares are trading at significant discounts to NAV (net asset value) across Europe. Quite simply, that means you can buy property shares for less than if you were to go out and buy the buildings themselves.
UK companies are trading at discounts of 55% to the last published values of the properties, which means that rather dreadful falls in capital value are already in the price.
European property companies can be classed as both Real Estate Investment Trusts (REITs) and non-REITS.
REITs offer significant advantages in terms of tax treatment. Shareholders in listed property companies face a double tax, as the company pays corporation tax while the investor pays tax on dividends and capital gains. In comparison, REITs do not pay corporation tax on the condition that (depending on the country's REIT regime) 80% to 100% of net taxable profits are distributed as dividends.
What about the relationship with direct property investment in bricks and mortar? In the short term, property shares respond strongly to equity market conditions rather than property market influences and therefore see higher volatility. However, over the longer term the correlation is stronger with the slower-moving direct property market. Also, the listed market responds quicker to change than the direct property market. This is because it is a more liquid sector and would typically lead a property market recovery by a number of months.
While credit remains hard to obtain, all investment markets will remain difficult, property included. Question marks hang over rental growth prospects, as financial occupiers and retailers alike will remain unable to pay higher rental levels until we leave the credit crunch behind.
One day, as the world begins to improve again, racier property stocks will again be bought for their capital appreciation, but for now boring remains best.
Vicky Watson is investment director of European equities at Scottish Widows Investment Partnership and manages the SWIP European Real Estate fund