Commercial property has found itself on shaky ground since the onset of lockdown, with offices and retail outlets lying dormant as activity froze. For open-ended property funds, the foundations appear to be crumbling, with imminent regulatory action raising the question of whether more investors will turn to their closed-ended counterparts, real estate investment trusts (Reits).
As the latest of three major rounds of fund suspensions since 2007 trapped investors’ money at the onset of the coronavirus pandemic, the Financial Conduct Authority (FCA) pledged to tackle the fundamental ‘liquidity mismatch’ of open-ended real estate in a major review launched in August. A final report is expected soon and will likely radically overhaul the sector’s boom-to-bust approach to daily dealing.
A formal notice period – between 90 and 180 days – is expected. Whether that will be sufficient to kill the sector altogether remains a moot point, but it is certainly likely to burnish the appeal of closed-ended rivals. Few professional fund buyers forecast a wholesale shift however, highlighting Reits’ own issues.
Hawksmoor multi-asset fund manager Ben Conway (above) turned buyer on several property trusts last year, as many moved to huge discounts to net asset value (NAV). Industrial and logistics funds were the major exception, benefiting from the e-commerce boom.
Conway expects the closed-ended space will benefit from the FCA’s review over the very long term, but cautioned that these structures were not a silver bullet. ‘I don’t think there’s going to be a switch that gets flicked and we see significant flows out of open-ended funds into Reits,’ he said.
The manager bought the ‘ridiculously cheap’ BMO Commercial Property (BCPT ) at a discount of more than 40% but said the £579m generalist trust potentially illustrates why some investors, such as financial advisers, remain wary.
Although fund closures have been reputationally damaging to the asset management industry, significant share price volatility and double-digit discounts acted as their own brake on trading, he said.
Matthew Saperia, a real estate analyst at broker Peel Hunt, pointed out that diversified Reits such as the BMO trust, Picton Property Income (PCTN ) and UK Commercial Property (UKCM ) were ‘proxies for the open-ended funds’. He expects them to benefit as the natural choice for those switching.
Conversely, Conway suggested there is a wider issue of too many undersized closed-ended vehicles, suffering from both a lack of diversification and liquidity in their shares. For the BMO fund, its largest central London asset – St Christopher’s Place off Oxford Street, which contains more than 50 shops and restaurants – dominates its performance.
Overall, he does not see a generalist buy-and-hold candidate that fits the needs of those who want to switch from some of the largest open-ended funds.
Specialists over generalists
Most wealth managers agree that Reits will enjoy an incremental and long-term increase in support rather than a mass transfer. They are more likely to recommend specialists in thriving sub-sectors such as ‘last mile’ logistics, and few picked out trusts with broad exposure.
Oliver Creasey (above), head of property fund research at Quilter Cheviot, said the timing of changes made by the FCA would be important. He said waiting periods of 90 days or more for withdrawals could prove ‘problematic’. If implemented with a delay, as is likely, he suggested the sector could be ‘peppered with outflows’ in the run-up.
Creasey added that a number of clients remain sceptical about shifting into Reits. ‘They have reasons for not wanting that exposure. Probably, they’re nervous about a swinging price to NAV,’ he said.
Mick Gilligan, head of managed portfolio services at Killik & Co, highlighted that a lot of money has already exited the giant funds in recent years. More than £2bn left the UK Direct Property sector in 2019, according to the Investment Association (IA).
In his experience, Reits’ leverage puts some off switching, despite the long-term benefits of enhancing the yield and gearing the capital return. ‘When things go wrong for the property sector, typically every 10-20 years, it is the most leveraged entities that fare the worst,’ he said.
Creasey said Quilter remains underweight property, as it expects a vaccine-fuelled recovery to lift other sectors to a greater degree. Nevertheless, he still rates the L&G UK Property fund, the country’s largest, as a ‘buy’ for investors who want to stick with open-ended exposure. Although reluctant to make direct comparisons, he likes £10.9bn warehouse group Segro (SGRO), whose shares have nearly doubled over three years before dividends.
While Creasey does not expect a boom in industrials in 2021, he thinks trusts with the most attractive office exposure, such as Derwent London (DLN), could surprise positively as workers head back in for three days a week.
Gilligan said Killik’s allocation to property trusts continued to creep up, with yields remaining favourable compared to bonds. Londonmetric (LMP) is one of its top picks for logistics exposure.
Killik is also backing a strong recovery in student accommodation provider Unite (UTG). The £4bn Reit, which is the UK’s largest private provider of student accommodation, is also on Quilter’s buy list.
No stampede yet
Though there has been a clear hit, the latest Investment Association data on open-ended funds does not provide evidence of a mass rejection of bricks-and-mortar just yet. In net retail sales, £543m flowed out of the UK Direct Property sector between September 2020 – when the first funds reopened – and the end of January.
Since reopening in October, the L&G Property fund had outflows of just over £680m to the end of February, according to Morningstar, shrinking to just over £2.3bn in assets.
A handful of funds, such as the M&G Property Portfolio – which was heavily exposed to UK retail property and suspended trading ahead of the pandemic in December 2019, essentially precipitating the sector’s latest crisis – remain gated, meaning outflows are all but assured when they reopen. M&G Property is set to reopen by the end of June.
There are signs, however, that some of that money could move into other funds. Net retail outflows from all property funds, including the Property Other sector, were £400m from September to December. But that was reversed in January, with £117m of inflows driven by more globally focused strategies investing in listed property.
Beneficiaries include funds such as Schroder Global Cities Real Estate , which Brewin Dolphin picked out for its holdings in attractive niches. Shakhista Mukhamedova, fund analyst at the wealth manager, said their property exposure remained ‘very selective’, favouring sectors such as warehouses. Preferred closed-ended options include Aberdeen Standard European Logistics Income (ASLI ) fund and £3.2bn UK giant Tritax Big Box (BBOX ).
Ben Seager-Scott, Tilney’s head of multi-asset funds, agreed the FCA’s proposed changes would discourage many investors and that some of that money would flow into Reits, which he thinks are more suitable for retail investors.
Across its range, Tilney has some exposure to bricks-and-mortar property funds rather than trusts, but Seager-Scott said these were long-term positions and they have never felt ‘trapped’.
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