A sharp repricing in industrial assets pushed UK Commercial Property (UKCM ) to underperform last year but Abrdn manager Will Fulton remains significantly overweight to the sector in order to drive income returns.

The £668m real estate investment trust (Reit) managed by Abrdn’s Will Fulton was upended by its heavy exposure to industrial assets, which make up 59% of the portfolio. The Reit registered a net asset value (NAV) total return decline of 18.1% in the 12 months to 31 December as highly-priced industrials saw their values tumble in the wake of the rising borrowing costs and an uptick in gilt yields following the disastrous Trussenomics policies.

Fulton said the ill-fated plans for unfunded giveaways by short-lived prime minister Liz Truss and her chancellor Kwasi Kwarteng, saw ‘previously acquisitive investors temporarily withdraw from the market’, with industrial assets in particular experiencing ‘significant yield expansion’.

Despite the large correction in the industrial property market, Fulton anticipates ‘the industrial portfolio will remain a key driver of portfolio income growth’, and he is ‘comfortable’ with his overweight. His decision has been reiterated this morning as US alternative investor Blackstone paid £500m for Industrial Reit (MLI ), a 42% premium to its closing price last Friday.

Four of the five assets with the largest negative contribution to performance were industrial properties in and around London, which Fulton said was ‘the most keenly valued part of the wider industrial sector’.

While capital values have taken a hit, UKCM’s portfolio joined in the wider trend seen across the property market for rental growth. The UK industrial market rental growth was up 10.4% over the year versus 3.8% for all property, with demand driven by third-party logistics groups and manufacturing.

Rent collection within the portfolio returned to levels recorded before the onset of Covid-19, with 99% of rents due across 2022 collected, while the average weighted unexpired lease term was maintained at 8.3 years, in line with the previous year and 28% of the rent is subject to inflation-linked rent reviews.

The strongest performing sector over the year was ‘alternative’ property, which had recorded a decline of 2.6% across the market. It encompasses a diverse range of properties including healthcare buildings, student accommodation, leisure facilities, and hotels.

Fulton said hotel trading ‘improved significantly over the course of the year’ thanks to increased room rates and higher occupancy.

The only acquisition made over the year was a hotel in central Leeds, where a 25-year franchise agreement is already in place with Hyatt Hotels for £62.7m.

‘The acquisition is in line with UKCM’s strategy to invest in operational real estate sectors that are expected to deliver resilient rental incomes and are backed by both strong local fundamentals and high-quality properties,’ said Fulton.

The only sale was a multi-let office building in central Birmingham, which was disposed of for £26.48m to Birmingham City Council at a premium to valuation and book cost.

Fulton is ‘deliberately underweight’ the office sector which he believes ‘faces challenges from uncertain occupier demand as tenants continue to assess the long-term impact of hybrid work patterns’.

Much has changed in the property market and while Fulton is expecting the UK to fall into a ‘mild’ recession this year and interest rates to stay higher for longer – reducing from their current level to 3% by the end of the year – he said the trust is ‘firing on all cylinders’, noting the strong EPRA earnings growth of 19% to 3.15p per share in 2022.

He said there is ‘real potential for continued rental growth’ and the industrials continues to be ‘one of the most under-supplied sectors in the country where demand remains positive’.

‘The company has the potential to benefit from both earnings growth and, in future, capital values,’ he said.

‘Following rises in interest rates, capital values have declined which presents an opportunity for valuations to increase as income grows and an expected interest rate cutting cycle commences which expands the margin between property yields and the risk-free rate, increasing the attractiveness of the sector to investors.’

‘UKCM is currently trading at a 34% discount to the December NAV, and yields 6.2% which represents a wider discount to the diversified property investment companies peer group trading on an average discount of 27% and dividend yield of 6.3%,’ said Numis analyst Colette Ord.

‘The board made reference to the wide discount and will focus on driving performance from the asset base to help improve share price performance,’ Ord said. ‘Given the low leverage, banking headroom and available firepower we view the shares as offering value, albeit against a backdrop of continued weak sentiment for real estate.’