Questor: Buy this high yielder for the UK commercial property recovery

Investment trust bargains: its buy-low, sell-high approach has weathered many bumps in the road

The prospect of further interest rate cuts by the Bank of England as inflation falls, lifting the pressure on businesses and consumers, has sparked a recovery in real estate investment trusts (Reits).
This makes it a good time to review our tip of AEW UK Reit, which we first recommended in July 2020 when shares in the top-performing commercial property fund languished 22pc below asset value in the first coronavirus lockdown, and offered an attractive 11pc dividend yield.
Our timing was good and the shares have gained 28pc since then as we correctly bet the company – now on an 11pc discount and still offering a high 9pc yield – would continue to pay shareholders 2p a share each quarter.
AEW UK has delivered its 8p annual payout for nearly nine years. This is an impressive feat given the dividend cuts and suspensions some Reits were forced into, either during the pandemic when many tenants couldn’t pay rents, or when borrowing costs soared as the Bank hiked base rate from nearly zero in December 2021 to 5.25pc 20 months later.
However, it’s not been a smooth ride for shareholders in the portfolio of 33 offices, shops, retail warehouses and industrial parks. The shares have tumbled 22pc since we last assessed them two years ago, shortly after they peaked at 128.6p in April 2022.
The decline to 93p today largely reflects the indiscriminate selling of listed property funds in 2022 and the mark-down of real estate as the yields on benchmark government bonds rose in response to rising interest rates.
In AEW’s case there was also concern about whether the dividend could survive intact, as for a few years there wasn’t sufficient rental income to fully cover the payments.
The uncovered dividend was mostly a byproduct of the trust’s buy-low, sell-high investment approach. Henry Butt, Assistant fund manager, says he and lead manager Laura Elkin are value investors who buy smaller commercial properties at low prices and high yields on comparatively short leases of four to six years. They then refurbish them and sell at higher prices when their rental values improve.
Because it can be easier to sell properties unlet and because it can also take time to reinvest the proceeds of property sales, this strategy can lead to periods when quarterly earnings per share slip below 2p.
Concerns about the dividend cover were heightened last year when a couple of tenants, including hardware retailer Wilko, fell into administration. This is why we didn’t include AEW UK in our roundup of generalist Reits in June when we picked Picton Property Income, up 10pc since we recommended it on a 30pc discount.
Happily, an update in July saw AEW UK take a big step towards restoring dividend cover with underlying quarterly earnings rising from 1.75p to 1.92p per share. A 2.4pc increase in its properties following a meagre 0.4pc rise in the previous three months provided evidence that commercial real estate had bottomed out.
News of the £6.3m sale of an industrial estate in Worcestershire for 33pc more than its valuation in March also showed an improving market and highlighted the fund managers’ successful record in locking in good gains. 
Over five years, the trust’s net asset value has grown 61.9pc, well ahead of the 10.8pc average of its rivals. Despite the setback of the past two years, the shares have largely passed on this growth with a total return of 55.2pc.
With further rental growth in prospect and £8.3m of cash on hand to buy or upgrade properties, this trust continues to be a good way to capture the recovery in commercial property. With two other Reits, Balanced Commercial Property and Tritax Eurobox, falling to bids this week, it’s possible predators will eye AEW UK Reit which we continue to rate a “hold”.
Questor says: Hold
Ticker: AEWU
Share price at close: 93.2p
Our tip of PRS Reit last December was already in the black but news of a shareholder rebellion last week has caused a further spike in the residential property fund’s shares, which are up nearly 12pc since our “hold” recommendation. 
Institutions owning 19pc of the shares have called for an extraordinary general meeting to replace the chairman and one of the directors. They are angry at the company for extending the fund manager’s contract by two-and-a-half years without consultation and for not doing more to tackle the damagingly wide 34pc share price discount of the past year. In response the board has said it will put forward proposals at its annual results next month. Hold for developments.
Gavin Lumsden is editor of Citywire’s Investment Trust Insider website