How to find 10% yields on property

Tom Bulford looks at a small-cap company that’s making very good returns from European property.

Running a property fund has not been easy over the past few years, but one man who has come through the difficult years is Ben Habib. This former Cambridge University graduate and corporate financier at the ill-fated Shearson Lehman set up First Property Group (AIM:FPO)  in 2000 at a time when investors were rather more confident in property than they are today. Times have not been easy since, but when I spoke to him last week Ben told me he sees some light at the end of the tunnel.

When it comes to the management of property or any other type of fund, money chases success and any manager with a good record can easily raise new financial ammunition. I asked Habib if he was keen to leverage his high reputation. His answer was interesting. “I am driven by ambition”, he told me, “but also by the fear of failure”.

This is a combination that serves any investor well, and although many feel that bricks and mortar are a safe bet, plenty can go wrong. Tenants can leave, rents can be unpaid, units can remain empty for months and once undesirable properties can become virtually unsalable. In a sector in which financial gearing is standard, apparently marginal changes can have dramatic effects.

Why Poland could be the answer

Property professionals spend their time appraising new opportunities, checking locations, assessing the outlook for the local economy, judging the strength of the tenancy agreements and much else. “We analyse everything to the nth degree”, Habib told me, and that has kept First Property out of trouble. But as well as this attention to detail, Habib has had one flash of inspiration. He has invested the majority of First Property’s funds into Poland.

While the stream of Polish workers arriving in the UK may have given the impression that this central European economy was a place to avoid, Habib saw it differently. Strategically situated between Germany and the fast-growing satellite states of the former Soviet Union, Poland has had the opportunity of combining the best of the east and the west, with one crucial advantage: it is not a member of the euro, and has not been dragged into this ghastly vortex into which most European economies are disappearing. Although growth is slowing this year, Poland’s economy has been doing pretty well, and is now starting to attract migrants of its own from southern Europe.

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Finding those 9-10% yields

First Property has assets under management of £353m, of which 71% is accounted for by Poland and 3% by Romania, while 26% are in the UK. These assets are held within six different funds from which First Property derives management fees. Here is a cloud on the horizon. The biggest of these six funds, accounting for over 60% of the assets, is the USS Fprop Managed Property Portfolio LP which is due to be wound up in 2015. Unless First Property can find a way of extending this mandate it will lose a large part of its fee income after 2015 and may even be a forced seller of property over the next two years – never an ideal situation.

Habib, though, does not intend to spend the next two years shrinking the group especially as the environment seems to be improving. With a cash balance of £13m that could be leveraged, he has some ammunition to buy properties, and is confident of finding opportunities.

The numbers do look attractive. With investors both in the UK and Europe clinging to prime properties and not daring to venture elsewhere, a large gap has opened between prime and secondary yields. First Property focuses on secondary locations, and yields of 9%-10% are available in Poland. With interest rates at record low levels and destined to remain there, the margin between the cost of money and rental yields is unusually high.

Banks are entering an upturn

What is more, the banks are now beginning to lend. After having their chequebooks firmly closed since 2009, there are signs of a change. Lloyds Bank, for example, is expanding its lending team and has recently refinanced an £82m property portfolio in the Midlands. Lloyds director Richard Round talks of “entering an upturn in the market cycle”. Meanwhile, foreign property investors are returning to Poland. Total investment in Polish commercial real estate hit $3.6bn in 2012, the highest figure since 2007. Eric Adler, global chief investment officer of Prudential Real Estate Investors, calls Poland ‘a good story at the moment.’

According to analysts at Arden Partners, the shares are backed by a net asset value of 23.3p and offer a yield of 5.5%. Given the uncertainty over the large USS mandate situation Arden has moved its recommendation from ‘buy’ to ‘add’. But how it is possible to ‘add’ to your holding without ‘buying’ shares is one of the City’s many mysteries.

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