Brexit has happened, and businesses now have a more certain future to plan for and are expected to increase investment. The government plans to spend billions on the UK’s regions outside London and the South East.

A better economic mood and more spending should see job creation and increased demand for residential and commercial properties in the regions.

Regional powerhouse

I believe shares in Palace Capital (LSE: PCA), a property investment company, will do well in such a scenario. Its portfolio of residential, commercial, and leisure properties are located mainly in the North, Midlands, and South West of England.

In August 2019, Palace converted to a real estate investment trust (REIT). REITs invest in properties and trade on public markets. Property income earned by a REIT is exempt from corporation tax, so long as they distribute 90% or more of that income as dividends and adhere to other conditions.

Shareholders in Palace, therefore, receive chunky dividends, and they receive them quarterly. Holding Palace in an ISA would mean the trailing 12-month dividend yield of 5.8% is tax-free.

Palace earned £19m in property income over the year that ended on 30 September 2019. At the start of that year, the market value of the property portfolio was £260m. Divide property income by property value and you arrive at a capitalisation rate of 7.31%.

Solid foundations

The capitalisation rate at Palace looks good compared to other REITs. Comparing the cap rate with the company’s weighted average interest rate of 3.2% suggests that the company earns a considerable excess return over the cost of financing its property investments.

A £100,000 property bought with a £34,000 deposit and a £66,000 mortgage, would have a loan-to-value ratio (LTV) of 34%, which is what Palace reports. High LTVs are concerning when interest rates rise. Palace’s LTV is above average for REITs in general, but not worryingly so.

Even if interest rates do rise, Palace converts a chunk of its variable rate borrowings into fixed-rate ones with instruments called interest rate swaps. It also, as mentioned earlier, has a good deal of spread between its cap rate and its average interest rate, to absorb modest rate increases.

Permanent structure

If a company gets liquidated, creditors get the first claim on assets. Once they get paid off through asset sales, what is left over, the net asset value (NAV), goes to the shareholders. Palace reports its NAV as 391p per share. Shares in Palace are trading around 330p at the moment, and an investor can, therefore, pick up £1 of assets for a little over 80p, assuming the reported NAV is correct.

Palace shares do look like a bargain, but there are risks. Failing to negotiate a trade deal with the EU would rock business confidence. Regional investment may not work, or not be as big as suggested. I would be looking at whether both phases of the HS2 rail link get approval or not. Approving these would show a real commitment to regional economies.

Nevertheless, there is a defensible long-term investment case for Palace. There is also a margin of safety with the share price being below the reported NAV per share.

Similarities and differences

From an investing point of view, property stocks and physical real estate share similar characteristics. For example, property prices can rise and fall with the potential to increase in value while you own a building. And shares also go up and down and have the potential to increase while you hold them.

With property, there is the opportunity to collect a yield from rental income. And with shares, we can harvest yield from the dividends. However, one big difference is the costs involved. Buying, selling and holding shares comes with relatively minor costs whereas taking on a property is an expensive undertaking. It can cost thousands to buy, sell and maintain a building.

We also have much greater liquidity with shares. Buying and selling are often as easy as making a few clicks of a computer mouse and we can convert our shares back to cash almost instantly if we choose to. However, deciding to sell a property is often the beginning of a long and difficult journey, which could result in your investment being tied up for months and even years in some cases.

Then there is the issue of diversification. If I went into buying and letting property today, even with mortgage loans, I’d struggle to diversify my investments across more than a few buildings. But when I buy shares in a property company, often my investment is spread across many underlying buildings.

Targeting commercial property in the regions

Palace Capital (LSE: PCA), for example, recently converted to a real estate investment trust (REIT) and has a portfolio worth around £276m diversified across regional commercial property. That’s another great thing about property shares, you can buy several of them, each targeting a particular area of the market. In that respect, Palace Capital’s focus on commercial property outside London in other regions is useful.

The company aims to invest in areas with “thriving local economies and strengthening fundamentals.” And today’s half-year results report for the period to 30 September reveals to us that compared to the equivalent period the year before, adjusted earnings per share rose 6.25%. The directors held the dividend flat and declared a net asset valuation of 391p, which compares to today’s share price of around 287p.

That discount to net asset value combines with the 6.6% dividend yield to suggest to me that the valuation is modest. But I think that situation reflects the uncertainty in the property market right now. Chief executive Neil Sinclair said in the report that the firm “stepped up” its development activity during the period. The idea is to meet the demand the company is seeing for “well located, fit-for-purpose property that delivers higher-quality income and capital growth.”

I’d be happy to buy a few of the company’s shares along with those of other diversified property companies right now.

There have certainly been many good years for buy-to-let investors. But I don’t think 2019 (or 2020) will be among them.

The two engines of profit for rental investors both appear to be grinding to a halt. House prices are already high and seem to be stagnant or falling in most regions of the UK. Alongside this, the costs and tax burden of being a landlord are increasing.

I think direct property ownership is best left to professionals who have the scale and financial firepower to build resilient, diversified portfolios. But I’m continuing to invest in property through listed property stocks.

Here, I want to look at two companies I believe should provide reliable long-term income and growth.

Big boxes pay well

One area where property demand is strong and seems likely to remain so is modern warehouse space. These massive ‘big box’ units are in demand to serve online retailers, supermarkets and other companies which need large-scale distribution facilities.

A number of dedicated warehouse property firms have emerged to take advantage of this trend. One of my favourites is Tritax Big Box REIT (LSE: BBOX) which owns £3.4bn of logistics property. This portfolio boasts an annual rent roll of £161m and a weighted average unexpired lease term of over 14 years.

The firm’s loan-to-value ratio was a conservative 27% at the end of 2018 and although the company is continuing to develop new sites, this is being done on a pre-let basis. That means building doesn’t go ahead until Tritax has secured a tenant, usually on a 15-20 year lease. In my view, this should restrict the downside risk for shareholders if market conditions soften.

Of course, I’m not the only investor to have spotted the attractions of this sector. Tritax stock trades roughly in line with its net asset value of 152p per share and the stock’s forecast yield of 4.6% isn’t especially high. That’s not a bargain, but is seems fair value to me. I’d be happy to buy the shares for a long-term income portfolio at this level.

Smart regional focus

London gets a lot of attention from property investors. But some industry insiders believe more attractive rental yields are available elsewhere. One company whose managers hold this view is Palace Capital (LSE: PCA), which owns and develops commercial property, primarily in regional university towns.

The firm has grown steadily since its flotation in 2013 but Neil Sinclair, Palace chief executive, says that “pricing in the market at the moment does not provide sustainable value.” As a result, he now plans to focus on maximising the potential of the PCA portfolio, rather than adding new sites.

As a potential shareholder, I welcome this focus on maximising value and cash returns. Dividend cover fell below 1x last year, and the firm’s cash generation didn’t cover its shareholder distribution. Portfolio occupancy of 87% also leaves room for improvement.

At the time of writing, the stock trades at a 33% discount to its net asset value, with a 7% dividend yield. I think this is a fair reflection of the risk and opportunity here.

But I’m also troubled that property prices have become far less affordable than they once were, compared to the average wage in Britain. Meanwhile, we could be about to see a sustained period of rising interest rates, which could work to keep a lid on property values going forward. Maybe prices will even fall. If such a scenario plays out, it could be harder to juggle rental income and costs in order to turn a profit. Because even if you do end up with net income gains, fluctuating property values have the potential to wipe out your earnings.

Diversified commercial property portfolio

I wouldn’t want to go into the buy-to-let business now because all the effort and hassle involved could lead to an overall loss rather than a gain. I reckon the good times for buy-to-let investors are probably behind us. Instead, I’d rather invest in one of the property-backed shares listed on the London stock exchange, such as Palace Capital (LSE: PCA).

The firm has a diversified portfolio of commercial property worth around £283m in towns and cities outside London that are “characterised by thriving local economies and strengthening fundamentals.” The directors look for areas with ongoing development activity, such as urbanisation and infrastructure improvements. Chairman Stanley Davis said in today’s half-year results report that in many such locations there’s been “a significant reduction in space.” Sometimes offices are in short supply, or it could be industrial property, and the situation is likely to have been caused by the planners allowing change of use to residential, or because of a lack of speculative development. In such situations, Palace Capital finds opportunities particularly, Davis said, “in locations such as Southampton, Winchester, Newcastle and York.”

He went on to explain that the company is different from its peer group because it has created “considerable” value for shareholders by buying up other property companies rather than making direct purchases of property. Shrewdly, the firm saved “considerable” amounts on Stamp Duty Land Tax (SDLT), and enjoyed “tangible” benefits with inherent tax losses and capital allowances by going down the corporate takeover route. This is one area in which those investing in Palace Capital shares could gain a considerable advantage over taking on buy-to-let property.

Plenty of firepower left

The firm declared its net asset value (NAV) per share at 421p today, which compares well to the current share price around 296p, suggesting decent value. The directors held the quarterly dividends at 4.75p, and the yield is running at more than 6%, which looks tempting and could be an easier income to collect than trying to get it from buy-to-let. Meanwhile, ongoing trading is good with gross rental income up 29% year-on-year. The total return during the first half of the trading year came in at 4%, which the firm defines as NAV growth and dividends paid. Looking forward, net debt is low at £84m, which gives the firm plenty of firepower for further expansion. I think the firm could be well worth your further research time.

However, the income potential of the bank remains strong. Alongside an improving strategy, this could make it a worthwhile investment opportunity. It could be worth buying alongside a FTSE 250 income stock which reported positive results on Monday.

Improving outlook

The last few years have represented a period of change for HSBC. The company has come under a significant amount of criticism from investors for its somewhat mixed financial performance. One problem it has faced is high costs at a time when many of its industry peers have been able to put measures in place such as headcount reduction in order to make their businesses more efficient.

In response, the company has decided to invest more heavily in faster-growing regions within its portfolio. As a result, it is seeking to focus a greater amount of capital across Asia, where the growth potential within the banking sector seems to be high. This could lead to a higher growth rate for the bank and may provide it with a competitive advantage versus industry peers who are focused on slower-growth markets.

Income potential

Of course, the banking sector may not be viewed as a sound place for income investors to buy shares. The financial crisis may be nearly a decade ago, but the uncertainty which it brought means that some investors may feel the chances of dividends being paid is lower than for other industries.

However, in the case of HSBC, its 5.3% dividend appears to be highly sustainable. Not only does the company have the potential to generate impressive earnings growth in future following its decision to focus on fast-growing Asia, its dividend is also due to be covered 1.4 times by profit in the current year. And with its shares trading on a price-to-earnings (P/E) ratio of 15, there seems to be further upside potential ahead for the long term.

Improving prospects

Also offering improving income prospects is FTSE 250-listed property investment company Palace Capital (LSE: PCA). It reported improving full-year results on Monday which showed that it was able to make progress with its strategy.

For example, during the year it was able to acquire its largest purchase to date. The RT Warren Portfolio helped to boost the company’s valuation to over £275m, while profit before tax moved 6% higher. This was boosted by a rise in net rental income of 22% to £14.9m, while revaluation gains and profit on disposals also made a positive impact on profitability.

With dividends rising by 3% versus the prior year, Palace Capital’s 5.5% dividend yield appears to be highly attractive. It is covered 1.1 times by adjusted profit, which suggests that it is sustainable. As a result, the stock could offer income investing potential over the long run, with a price-to-book (P/B) ratio of 0.8 indicating that it offers a wide margin of safety.

With that in mind, here are two stocks which could be worth a closer look. They have dividend growth potential as well as impressive business models for the long term.

Improving performance

Having endured a challenging number of years, the future for diversified resources company BHP Billiton (LSE: BLT) appears to be relatively bright. The company has made numerous changes to its business model in recent years that seem to have improved its sustainability and profit growth potential. For example, it has spun-off various assets into a new entity, South32. This has helped BHP Billiton to become more focused on its low-cost asset base, where it could have a competitive advantage versus a number of its industry peers.

With commodity prices having risen somewhat in recent months, the company’s profit growth prospects have improved. It is expected to record a rise in its bottom line of 13% in the current year. This puts it on a price-to-earnings growth (PEG) ratio of just 0.9, which suggests that it could offer significant upside potential.

Dividend growth

With dividends being covered 1.6 times by profit, they appear to be highly sustainable. They could move higher if profit growth remains robust. This seems relatively likely, since the supply surplus of various commodities including oil now looks to be significantly reduced. This may mean that the prices of oil, iron ore and other commodities increase in future and lead to higher profit and dividend growth for the company over the long run.

Also offering dividend growth potential at the present time is UK property investment company Palace Capital (LSE: PCA). The company focuses on commercial property that is mainly outside London and reported positive first-half results on Monday. They showed that dividends increased by 5.6%, while the value of its property portfolio increased by 10.7%. Its average cost of debt remains relatively low at 2.9%, while its overall occupancy rate of 89% suggests that demand for commercial property remains high.

Total return potential

In the last three years, the company has increased dividends per share by around 47%. It could have scope to raise shareholder payouts yet further in future, with its outlook being relatively positive. For example, next year it is expected to increase its bottom line by around 5%. Since it trades on a price-to-book (P/B) ratio of just 1.4, it could also have capital growth potential.

With a dividend yield of 5.5%, Palace Capital could offer a high income return. As well as this, its low valuation and dividend growth potential mean it could be worth buying for the long run.

In this piece I’m going to look at two potential buys — a small-cap upstart and a big name property stock with a long pedigree.

Rapid growth

AIM-listed Palace Capital (LSE: PCA) has delivered rapid growth since its flotation in 2013. The reported value of its property portfolio has risen from around £60m in 2014 to £183.2m at the end of March.

News today suggests that this value could soon head north of £200m. Palace has announced plans for a £67.8m deal to acquire RT Warren, a property company with a £71.8m portfolio of industrial and residential properties.

Palace plans to raise £70m through a share placing to fund this deal. The group’s plan is to sell the London residential properties and focus on improving the rental yield from the commercial properties.

There are several things I like about this. The first is that by raising the whole value of the deal in fresh equity, management expects to deliver a significant drop in leverage. The group’s loan-to-value ratio is currently quite high in my view, at 43%. But if the RT Warren deal goes through as planned, this is expected to fall to less than 35%.

The second thing is that the RT Warren assets generated a rental income of £3.6m last year. This gives a rental yield of about 5%, which is below the group’s average. However, management believes a number of the new properties have the potential to deliver higher returns.

Palace’s special focus is on active management to maximise rental yields. So far, it’s been quite successful. Net asset value per share rose by 7% last year, while adjusted pre-tax profit rose by 20% to £6.7m.

The shares currently offer a yield of 5%. For small-cap income investors, they might be worth a closer look.

A 35% discount

FTSE 100 property group British Land Company (LSE: BLND) has a £13.9bn portfolio that’s focused on prime London office space, and retail centres around the UK.

Neil Woodford has been buying British Land stock for his income funds, most recently in August. And although some of Mr Woodford’s picks have come in for a lot of criticism this year, I believe this one makes sense.

The stock currently trades at a 35% discount to its net asset value of 915p, and offers a forecast dividend yield of 5.1%. British Land is well funded and the portfolio has a loan-to-value ratio of less than 30%, which seems fairly prudent.

The group doesn’t need to refinance any of its borrowings until early 2021 and has a weighted unexpired lease term of 8.3 years. Occupancy stands at about 98%.

One risk is that some of the group’s major tenants — perhaps retailers — could fall into financial distress and default on their rent payments. However, despite this possibility, I think it’s fair to say that forward visibility of earnings is pretty good.

In my view, the stock’s discount-to-book value is large enough to provide some protection against falling prices and lower rents. British Land has been on my watch list for a while. I’m certainly getting closer to making a purchase.

However, despite Gresham’s rapid sales growth, shares in the business have barely budged over the past five years. So what’s gone wrong? 

What has gone wrong? 

Gresham’s speciality is alternative asset management, which simply means that the business invests money on behalf of clients into alternative assets such as property, renewable energy and venture capital funds. Profits from these activities are lumpy and the business has been unable to report a sustainable profit. 

Nonetheless, it looks as if management is now confident that the business really is on track to sustainable profitability. In today’s trading update CEO Tony Dalwood said: “The Group has achieved a number of milestones including passing through £0.5bn AUM….I am pleased to report that we are on track to achieve profitability on a run-rate basis in the second half of this year.” Pre-tax losses improved from -£1.2m to -£0.8m for the period under review. 

I’m excited about Gresham’s prospects. It seems that more and more investors are looking to alternative assets to provide returns as interest rates remain depressed and equity valuations continue to rise. The asset manager should benefit from this trend. What’s more, management has plenty of firepower to buy up bolt-on growth.

During the first half, the firm sold an inherited legacy property asset Southern Gateway for gross proceeds of £7.3m, allowing it to pay down outstanding debt and improving tangible realised assets to £27.4m — around 67% of Gresham’s current market cap.

Discount to asset value

Investors also seem to be overlooking the opportunity at real estate investment trust Palace Capital (LSE: PCA).

Just like Gresham, Palace is a specialist. The company’s area of expertise is commercial property and management has proven that it knows this area well. 

Since the end of 2014, shares in the REIT have returned around 71% excluding dividends as net asset value has expanded. Over the same period, Palace has paid out 51p per share in dividends for a total return of 90%, or around 17.4% per annum, an extremely impressive return for a company with a market capitalisation of less than £100m. For some comparison, over the past five years, the FTSE 100 and FTSE 250 have produced annualised returns of 9.4% and 14.7% respectively including dividends. 

And I believe Palace still offers value for investors. Today, the shares are changing hands at 383p with a dividend yield of 4.9%, but the net asset value of the firm is closer to 443p, 16% above the current market price. 

Considering the market-beating yield, and the discount-to-net assets value, I believe this could be an attractive buy for long-term investors seeking a steady income from property. 

I believe Anglo Pacific Group (LSE: APF) is one such company. Anglo Pacific is a resource royalties company, which means it’s not as exposed to commodity prices as traditional miners. It has revenue-based royalty deals limiting direct exposure to operating and capital costs of the underlying mine operations. The beauty of this business model is that it’s hugely cash generative and there’s very little capital required to generate returns.

Cash cow

In 2016 the company received £19.7m in royalty income from investments and free cash flow for the period was £13.2m.

The majority of this income is returned to shareholders with a minimum annual payment of 6p per share. Management has committed the company to pay 65% of earnings out to shareholders, and at current revenue run rates, the 6p per share payout will have to be revised upwards this year.

However, it doesn’t look as if the market understands the full dividend potential here. Management is looking to pay 65% of earnings per share to shareholders via dividends, but City analysts have only pencilled-in a dividend payout of 7p per share for 2017 on earnings per share of 15.6p. A payout ratio of 65% is equal to a dividend of 10.1p per share giving a yield of around 8.7% at current prices. Of course, management may decide to adopt a more conservative dividend policy if earnings come in below expectations, but right now, it looks as if Anglo Pacific is an extremely undervalued dividend play.

Income and capital

I believe Palace Capital (LSE: PCA) is another hidden dividend champion. The company is a commercial property investment firm with a portfolio worth £185m and a net asset value per share of 419p. At the time of writing, shares in the firm are trading at a near 15% discount to NAV and it is here, as well as the company’s 4.5% dividend yield, where I believe the value lies.

City analysts believe the company is set to hike its dividend payout by more than 10% for the year ending 31 March to 18p per share, which would give a dividend yield of 5.1%, an extremely attractive yield for a solid property investment.

At the same time, investors will be able to take advantage of Palace’s discount to NAV. By buying the shares at a 15% discount to the last recorded net asset value, there is a near 18% upside available in addition to the yield of 5.1%. If the company manages to increase its NAV during the period, the return could even be even higher.

So, if you’re looking for a stock that can provide both income and capital growth with reduced risk, Palace Capital might just be the one.

Strong performance

Reporting on Thursday was insurance specialist JLT (LSE: JLT). It delivered a strong performance in the first quarter of the year, despite facing difficult trading conditions. In its Risk & Insurance division, the momentum in Speciality was continued after success in prior periods. Key client wins helped the business to offset economic challenges. The integration of Construction Risk partners in the US continues to proceed as planned and could offer growth potential for the business in the long run.

In JLT’s Employee Benefits division, the restructuring benefits are yet to bear fruit. However, the division continues to perform well and could gain an uplift from the changes made to the business last year. It is on target to post organic revenue growth this year, while a 15% profit trading margin is the goal for 2018.

In terms of JLT’s income appeal, its current dividend yield of 3% may not sound particularly enticing. However, with dividends being covered 1.6 times by profit last year, there is scope for a rapidly-rising dividend in future. In fact, JLT is expected to record a rise in shareholder payouts of over 5% per annum during the next two years. And since its shares trade on a price-to-earnings growth (PEG) ratio of 0.9, capital growth potential may also be high.

High yield

Also offering upbeat income prospects is commercial property investment company Palace Capital (LSE: PCA). It currently yields around 5%, which is significantly higher than the FTSE 100’s dividend yield of 3.7%. And since the company’s shareholder payouts are currently covered around 1.2 times by profit, they seem to be highly sustainable at their current level.

Looking ahead, the commercial property sector in the UK faces an uncertain future. The impact of Brexit could be somewhat negative, since it may lead to declining confidence in the UK economy. Alongside this, higher inflation may lead to reduced consumer confidence. In the medium term, this may cause profitability for the retail sector and other industries to decline, thereby leading to reduced demand for commercial property.

Despite this, Palace Capital could prove to be a sound long-term investment. It has a price-to-book (P/B) ratio of just 0.85, which indicates that its shares are cheap. Therefore, with a wide margin of safety and a high dividend yield, it could offer a rising share price and generous income return in 2017 and beyond.