‘Shops, sheds, and digs’ helped save property trusts from a disastrous 2023, setting the sector up for a ‘steadier’ year, says Deutsche Numis.

Last year proved to be another rollercoaster ride for property investors as high interest rates and macroeconomic and geopolitical uncertainty weighed. UK real estate investment trusts (Reits) swung from 15% losses to 15% gains, finally ending the year 6.2% ahead – according to the iShares UK Property exchange-traded fund (ETF).

Deutsche Numis director of sales Justin Bell said it was ‘really just three months’ that rescued the year, with gains made in January as the reopening of the Chinese economy lifted market sentiment, and the catch-all rally enjoyed in November and December on hopes of cuts in interest rates.

‘The rest of the time [was] an uphill battle with very little investor demand for beleaguered Reits given the direction of travel of Sonia [the interbank lending rate that replaced Libor in 2021],’ he said.

Volatile yields on 10-year gilts also took their toll as markets gyrated on the prospects for interest rates, softening in January to 3.1% as government bond prices rose, before grinding to 4.7% in August, and then correcting sharply in the fourth quarter to bring them ‘back down to a much more palatable 3.2%’, said Bell.

‘While still a close proxy, correlation between the sector and long gilts broke down temporarily in March and April, with the banking crisis driving demand for safe-haven assets and sparking fears of a credit crunch in leveraged assets [such as Reits],’ he said.

It wasn’t all bad news from the property sector in 2023, with retail, industrial, and student accommodation all rallying over the year.

Bell said ‘shops, sheds, and digs’ doesn’t quite have the same ring to it as ‘beds, sheds, and meds’ – which dominated in 2021, but nevertheless, the battered retail sector ‘saw a great comeback in 2023’.

It was led by Shaftesbury (SHB), which invests in London’s West End and owns property in Covent Garden, Carnaby Street and Soho. Shopping centre owner Hammerson (HMSO), which owns the Bullring in Birmingham and Brent Cross in London, was higher over the year and ‘de-leveraging is reported to be coming soon’, said Bell.

The industrial sector also ‘put in a solid performance, aided by a late rally in warehouse developers Segro (SGRO) and Tritax Big Box (BBOX ), while student accommodation providers Unite (UTG) and Empiric Student Property (ESP) benefited from the ‘prospect of lower rates on top of very strong rental growth for this year, and reduced inflationary cost pressures’.

Offices were still under pressure as the work-from-home culture saw businesses continue to cut down the amount of space they needed. However, the sector was not the weakest performer. That title went to long income and healthcare trusts where ‘there is greater sensitivity to long-term inflation assumptions in the rental growth prospects and some of the yield expansion was perhaps slower to feed through into valuations than in other sectors’.

The disparity in the returns across property trusts showed the ‘flaw of averages’, with the top five stocks delivering a 28% return whereas the worst five average a decline of 34% in their share price, which Bell said was a ‘remarkable spread of fortunes’.

Best performers

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Trust	Share price increase
Shaftesbury Capital (SHB)	29.70%
Industrials Reit (MLI )	Taken over at 168p - 42% premium
Workspace (WKP)	27.70%
Sirius Real Estate (SRE )	27.40%
Civitas Social Housing (CSH )	Taken over at 80p - 44% premium

Worst performers

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Trust	Share price decline
Regional (RGL )	40.30%
CLS Holdings (CLI)	35.70%
Helical (HLCL)	33.60%
Phoenix Spree Deutschland (PSDL )	30.90%
Residential Secure Income (RESI )	29.70%

The fortunes of share prices varied widely, but the underlying theme of 2023 was the erosion of capital values with a steady occupational market.

The office sector saw total returns dive 11%, in a ‘striking, if not unsurprising picture’, said Bell, while ‘retail values continued to slide but were more than offset by the high income returns on these assets’. Industrials offered 5% total returns ‘entirely from income’.

While total returns across all property was broadly flat, up 0.3%, rental growth was positive across all sectors over the year, although below inflation in every area except industrials.

‘Whilst rental growth alone doesn’t tell the full story of the economics…it is nevertheless a helpful offset to continued outward yield shift in the year,’ said Bell.

‘If the consensus holds that bond yields are steady or softening, with supply-demand drivers in place for rental growth in many sectors, the backdrop should allow 2024 returns to be closer aligned to the underlying real estate, rather than the macro.’

Calm after the ‘easy money’

Property investors may have already made the ‘easy money’ in the widespread rally enjoyed in the final quarter of the year, but Bell said he is ‘hopeful that we are treated to a steadier ride in 2024’ thanks to the end of aggressive monetary policy that has blighted the sector.

‘When viewed through the lens of peak rates, rather than staring up the escalator, the sector makes a lot more sense to own with more confidence over valuations, and we have definitely started to see the return of the generalist equity investor from the sidelines,’ he said.

‘When investors are making their asset allocation decisions at the start of this year, will they want to maintain significant underweighting to a sector on a 16% discount to – hopefully – stable valuations, with a 4.5% dividend yield, underlying rental growth and significant ongoing M&A?’

Given these metrics, Bell said the property is ‘not a sell’.

The softening in interest rates will also provide the managers of property trusts with the ability to once again access capital and ‘originate interesting deals’.

‘Recent equity raises in the second half shows there is capital willing to support those with pipelines in the right sectors,’ said Bell.

However, he added that trusts ‘constrained by their balance sheets, equity rating, or size will continue to be vulnerable to shareholder pressure on boards to find solutions’.