REITs have been extremely attractive for income hungry retail investors during the past seven years. However, the property market moves in cycles and there are an increasing number of signs that we have reached the top of the latest one, meaning investors chasing income could suffer a painful loss of capital
Shares in REITs are driven by two factors. Firstly, rental income from property has steadily risen as the UK economy recovered and companies need more space. Secondly, UK property has become increasingly attractive for overseas investors to store their wealth, this increase in demand has driven up property prices. However, there are a number of issues undermining this strong run.
Mike Prew, a property expert, paints a strong case for the idea that demand for commercial property is beginning to dry up. "The buying power of petrodollar rich sovereign wealth funds has been seriously undermined by the collapse in oil prices. Closer to home the UK-listed REITs have also had their wings clipped as investors pulled money from the sector in February at the fastest rate since 2008. In the London market there is 26m sq ft of new office space due for completion within the next four years." That is the staggering equivalent of 40 new Gherkins in four years.
Political risks rise
Political risk to the property market is also on the rise. Leaving the EU would undoubtedly be bad for UK property prices. Our new London mayor Sadiq Khan also poses a threat, he has set out a range of policies to curb foreign investment into the London market at the expense of residents.
Dividend cover is one of the easiest ways to check whether income is vulnerable. A score of two times cover is usually considered safe, but the average for the commercial property sector is currently 1.3 times. Shares in British Land and Land Securities have fallen 20pc during the past six months but this is not a buying opportunity as they still trade on more than 20 times forecast earnings.
Time to sell?