Property puzzle

Ian Cowie pores over the prospects for property.


Does last month’s closure of the department store Debenhams, following the failure of several other household names, mean it’s curtains for property funds? Will working from home (WFH) make office space seem as desirable as an overcrowded commuter train? This investor believes there are two answers to both questions.

Yes, the outlook is grim for open-ended funds holding commercial property that is hard to sell in a hurry, also known in City jargon as “illiquid assets”. In plain English, Mark Carney, former governor of the Bank of England, said: “These funds are built on a lie, which is you can have daily liquidity (for assets that) fundamentally aren’t liquid”.

That’s why the insurance giant, Aviva, stopped allowing withdrawals from its property unit trust 14 months ago and now says it intends to wind it up. The insurer added it may take another two years for investors to get their money back, which would mean their cash had been frozen for more than three years.

Now here’s an alternative, more positive view. No, it isn’t curtains for closed-ended investment companies that can afford to take a longer-term approach to property. Investors in this sector - including your humble correspondent - can still find opportunities for income and growth.

That’s why the AIC offers no fewer than eight relevant sectors including Property - Debt; Property - Europe; Property - Rest of World; Property - UK Commercial; Property UK - Healthcare; Property UK - Logistics; Property UK - Residential and Property Securities. Underlying assets range from tower blocks and shopping malls to health centres, student accommodation and warehouses that store and deliver everything we buy online; here and overseas.

The contrasting characteristics of closed and open-ended funds in this sector might have sounded like a technical distinction before recent market shocks. Now they turn out to be very important differences that statutory regulators are struggling to reflect in their rules.

The fundamental difference remains fairly straightforward. One pooled fund way of accessing property allows investors to get back into cash when we want to, without forcing a potential fire-sale of assets. The other doesn’t.

Fund managers of closed-ended investment companies, unlike unit trusts, are never forced to sell assets to meet redemptions when property’s popularity and prices plunge. They can let Mr Market find the level at which buyers match sellers.

This won’t always be a comfortable experience for existing investors when an asset class falls from favour and there are more sellers than buyers. That’s why several investment companies in the AIC’s Property - UK Commercial sector currently trade at double-digit discounts to their net asset value (NAV).

For example, shares in the £1.26 billion giant BMO Commercial Property (stock market ticker: BCPT) are priced 25 per cent below their NAV, according to Morningstar. Similarly, Standard Life Investments Property Income (SLI) trades on a 20 per cent discount and Schroder Real Estate (SREI) is priced 25 per cent lower than its NAV.

Now bear in mind that these three companies currently yield dividend income of 4.7 per cent; 5.2 per cent and 4.9 per cent respectively. Of course, dividends are not guaranteed and can be cut or cancelled without notice and you might get back less than you invest. Even so, according to Morningstar, these three examples delivered total returns over the last year of 18 per cent; 1.2 per cent and 20 per cent respectively.

Even more dramatic contrasts between pricing, performance and yields can be found. For example, Ediston Property (EPIC) trades at a 19 per cent discount to NAV despite delivering total returns of 46 per cent over the last year and continues to yield 7.3 per cent.

I am still dithering about whether to buy one of the above but am glad I already hold shares in Aberdeen Standard European Logistics Income (ASLI), which owns warehouses and distribution hubs for online retail.

I subscribed for the initial public offering (IPO) at £1 per share in December, 2017, and topped up at 75p during the depths of the pandemic panic in March last year. Over the last year they have delivered total returns of 31 per cent and, priced at 119p at the time of writing, yield dividend income of 4.2 per cent.

Whether depressed valuations and elevated yields in some property companies represent a buying opportunity or merely reflect permanent changes in the way we earn and spend is open to debate. Some people believe WFH is a temporary phenomenon and that the ‘new normal’ will look very much like the old normal after the coronavirus has been defeated.

Fewer folk claim that the trend toward online retail will be reversed but others argue it is already fully reflected in share prices. Two views, as they say, make a market.

Either way, shareholders in property investment companies need not fear having our cash frozen out of reach for years. More positively, fortune may favour the brave and buyers in an unfashionable sector can hope to identify overlooked and underpriced bargains.