Value & Index Property (VIP ) swung to a first-half loss as it completed its transition to a pure-play property trust just as real estate hit the skids.

The £100m trust has completed its shake-up two years after company founder Matthew Oakeshott proposed it drop its longstanding dual investment policy in UK equities and property to focus on UK real estate long leases with index-linked rent reviews, rising in line with inflation.

Oakeshott and his OLIM co-manager Louise Cleary have had to navigate the trust through this change at a tough time in the commercial property market, which has been hit by higher debt costs on the back of rising interest rates, and rising gilt yields that have put downward pressure on real estate valuations.

They noted in recent six-month results to 30 September that while the MSCI UK Quarterly Property index made gains in the first half of the year, they were reversed in the second half as ‘rising bond yields and slower rental growth force property valuations yields up and capital values down’.

The retreat in the property market saw the trust’s net asset value (NAV) drop 6.3% from 314.3p to 294.4p per share, although including dividends, a 2% total return of 2% beat the index’s 1.3% decline.

While rental income jumped 29% to £4.1m on the same period last yeare, the trust swung to a pre-tax loss of £7.2m from a profit of £10.4m a year ago.

Cleary and Oakeshott said all sectors had been affected over the past six months, with ‘offices declining further, retail giving back its recent gains, and the industrial sector suffering worst in the short-term as it had become the most overheated’.

They said property transaction volumes had slowed markedly since the summer, especially in industrials and retail warehousing.

‘Many sales [are] only going through after agreed prices have been “chipped” by buyers and many more properties [are] having to be withdrawn from the market unsold. Buyers are now few and far between as they wait to see how far yields move out,’ they said, adding the open-ended property funds have also become forced sellers to meet withdrawals, further making it a buyers’ market.

The fund managers warned offices were in ‘long-term decline’, while star performer retail warehousing ‘had its moment in the sun…but that has ended’, and could see capital values falling further in warehouses and industrials.

Resilient retail?

However, there could be some surprise property winners, in the retail sector as high streets and shopping centres bottom out. ‘With consumers so squeezed, values are still drifting down, but they may prove more resilient than low-yielding investments in other sectors,’ they said.

‘Rebased retail rents are now more affordable, with most retailers enjoying short, flexible leases. Savvy high street occupiers who have not over-expanded in recent years, have taken advantage of lower rents and higher vacancy rates to secure favourable high street positions in more prosperous areas.’

They added that the revaluation of business rates, that hit in-town shopping centres and high street unfairly, could be a ‘game-changing lifeline’ to the retail sector.

Alternative investments, such as leisure facilities, hotels, and care homes, and the index-linked leases they offer, were likely to be the ‘survivors’, they believed. These have become increasingly important to institutional investors thanks to their index-linked incomes and Cleary and Oakeshott said they should continue to outperform more traditional property sectors.

This includes pubs, as long as they are ‘food-led pubs with outside space, in suburban, smaller town and rural locations’ which have been trading well post-pandemic.

‘They will remain long-term winners but serious shortages, especially of kitchen staff, and rising energy prices will hit all hospitality businesses over the next year,’ they said.

‘Meanwhile, nimble restaurant and pub operators are taking advantage of retailers’ woes to open new sites, at low, affordable rents.’

They added that hotel occupancy has recovered well since the pandemic, and those in prosperous smaller towns and rural areas serving ‘stay-cationers, workers, and businesses continue to perform really strongly’ and are a safer bet than city centre and airport hotels. Suburban health and fitness clubs have also seen a benefit from the shift to working from home.

Where yields are too low

When it comes to alternative property investment in student housing, tenant numbers are rising and ‘investments on long leases to well-established universities have been in great demand’, but the pair said yields on student housing are now ‘too low in comparison with safe, indexed investments across the commercial property market as a whole’.

Care homes, also remain ‘challenged’ and ‘values are under downward pressure’ as bed vacancy rates are rising quickly due to increased deaths, staff shortages, and slower admissions.

Property investors learned a ‘stark lesson’ from the Covid-19 crisis, to ‘stay on the right side of structural change’ and Oakeshot and Cleary said to do so they will ‘avoid offices and focus firmly on properties let to strong tenants at affordable rents on long, preferably index-linked, leases provided they are valued at realistic yields’.

‘Secure index-linked, UK property still offers better long-term investment value at lower risk than UK conventional or index-linked gilts, which only offer long-term investors negative or negligible real yields and a painfully bumpy ride,’ they said.