“All the building blocks to perform in the future”
Managers of property investment companies talk opportunities and challenges.
Investment companies now manage £23bn of UK property assets, compared to £7bn in open-ended funds1, making them the dominant vehicle for private investors to gain diversified exposure to this asset class.
While some open-ended property funds have suspended trading to allow them to return cash to shareholders, property investment companies trade on deep discounts. For example, the average investment company in the Property – UK Commercial sector trades at a discount of 26.0%, while the average discount in the Property – UK Logistics sector is 26.1%.
Falls in share prices and wider discounts for these companies have led to an increase in yields. The Property – UK Commercial sector now yields 7.4% and the Property – UK Logistics sector yields 5.4% on a trailing basis based on last year’s dividends.
Property investment company shares are traded on the stock market. Mostly structured as real estate investment trusts (REITs), they offer exposure to a wide range of property types, from warehouses and offices to supermarkets and care homes.
To discuss the challenges and opportunities in the property sector, a media webinar was held today by the Association of Investment Companies (AIC) featuring Richard Shepherd-Cross, Fund Manager of Custodian Property Income REIT and Bjorn Hobart, Investment Director of Tritax Big Box REIT.
Their comments are collated below, alongside views from Jason Baggaley, Fund Manager of abrdn Property Income Trust, Will Fulton, Fund Manager of UK Commercial Property REIT, Laura Elkin, Portfolio Manager of AEW UK REIT and Nick Montgomery, Fund Manager of Schroder Real Estate Investment Trust.
Bjorn Hobart, Investment Director of Tritax Big Box REIT, said: “The economic outlook in the UK looks set to remain challenging in the near term, with inflation proving stubborn and the impact of higher interest rates likely to further slow the economy in the coming months. Against this backdrop, our portfolio remains strong having been carefully constructed to be highly resilient in more uncertain economic conditions. We have modern, well-located assets let to world-class tenants on long leases. This underpins continued rental income growth and performance and we are on track to deliver our tenth year of 100% rent collection.
“Market dynamics also remain favourable with a resilient occupational market supported by key structural drivers, notably the growth of e-commerce, deglobalisation and supply chain optimisation, and customers’ increasing focus on ESG performance. The supply of new space remains controlled and while vacancy has ticked up, it remains very low in historic terms contributing to further market rental growth. We continue to add value through asset management activities and our portfolio valuation has been further supported by investment disposals at and above book valuation levels.”
Nick Montgomery, Fund Manager of Schroder Real Estate Investment Trust (SREI), said: “Economic conditions over the past couple of years have been characterised by persistent inflation, rising interest rates, market volatility and lower levels of economic growth. This led to the sharpest correction in real estate values since the global financial crisis. Whilst SREI asset values were impacted, a diversified, higher yielding portfolio combined with good progress over the period delivering on value-add asset management initiatives resulted in sustained relative outperformance of the underlying portfolio. As a result, whilst the MSCI benchmark recorded a total return of -16.0% in the year to 30 June 2023 the SREI portfolio delivered -10.7% and the strong income growth enabled SREI to deliver further increases in the dividend which remains fully covered by earnings.
“The strength of the SREI balance sheet, where 74% of £175.6 million total borrowings has an average maturity of 12.8 years, and a fixed average interest rate of 2.5%, is a key competitive advantage and there will be limited impact on the company from higher interest rates.”
Laura Elkin, Portfolio Manager of AEW UK REIT (AEWU), said: “Our strategy of acquiring undervalued assets that provide opportunities for capital and income enhancement through asset management has put us in good stead for navigating the current economic climate. Following the completion of key asset management transactions at a number of our holdings, AEWU’s portfolio achieved a like-for-like valuation increase during the past quarter, demonstrating the effectiveness of our active strategy in delivering countercyclical performance.
“We have seen resilience in the occupational demand from our tenants, which has allowed us to grow earnings per share and continue paying our market-leading dividend of two pence per share per quarter for 32 consecutive quarters.”
Investment company discounts
Jason Baggaley, Fund Manager, abrdn Property Income Trust (API), said: “The whole sector is suffering from wide discounts and it is difficult to rationalise some of them. Looking at API it certainly feels as though the current discount provides much greater upside potential than downside, but it is not clear when the recovery in pricing will happen. We believe that we have a clear route to a covered dividend and that recent discussions with the board have laid out a pathway to seeing a narrowing of the discount.”
Will Fulton, Fund Manager of UK Commercial Property REIT (UKCM), said: “In my opinion UKCM, particularly with its elevated discount, certainly does represent a strong investment case. UKCM offers a 5.9% dividend yield off an exceptionally rare, in its history, 31% discount to NAV. It also has all the building blocks to perform in the future – allocation to the best property sub-sectors, great built-in potential for income growth (both through the conversion of historic low industrial rents to today’s rent rates in a low-supply market, and from completion of a development next year which will switch on a further income stream), excellent balance sheet management and control of the cost side of the earnings equation with the lowest percentage of debt in the peer group (15.6% loan to value at 30/6/2023), low cost of debt with 88% at a low fixed interest rate of 2.88%, and one of the lowest ongoing cost ratios.”
Richard Shepherd-Cross, Fund Manager of Custodian Property Income REIT, said: “I think that premium/discount to NAV is a poor measure of worth. A much better measure of worth for a REIT is earnings and earnings growth potential through rental growth. The current discount of 12% provides a great opportunity to investors who can lock into a dividend yield of 6.4% from a portfolio with 15% latent rental growth potential to support future earnings growth.”
ESG, environmental and social impact
Richard Shepherd-Cross, Fund Manager of Custodian Property Income REIT, said: “ESG strategy is so enmeshed with day-to-day property management that it has simply become how to manage property. We target EPC improvement at every opportunity. The weighted average EPC has improved from C (58) to C (56) in the last quarter alone. We are rolling out solar PV wherever possible. Ideally, we will fund the capital cost of installation and tenants will commit to a power purchase agreement to buy solar generated electricity from us. We forecast seven year pay back on the capital investment. We have installed publicly accessible EV chargers on our retail parks, which provides a strong social, environmental and financial benefit.”
Will Fulton, Fund Manager of UK Commercial Property REIT (UKCM), said: “Our strategy is both simple and, I believe, effective. We focus on two aspects of ESG – regulatory, where we successfully target EPC energy ratings A, B and C to comply with expected legislative control in 2027/30 and currently a strong 80% of our property meets or exceeds an anticipated 2027 ‘C’ label requirement. We also have an aspirational focus, very much linked to delivering shareholder return, where we target a carbon net zero status by 2030 (for the smaller amounts of energy we control the use of) and 2040 for our entire portfolio. As well as providing a positive environmental contribution, this is very important from an investment returns perspective.
“Socially, we engage with tenants and the community, which includes us sponsoring the 2023 Youth & Community element of the Kingston International Film Festival, and utilising our modern Reading office’s roof terrace for very popular tenant gardening activities – good for gardeners, also good for social interaction, all of which leads to a popular office to occupy.”
Jason Baggaley, Fund Manager, abrdn Property Income Trust (API), said: “We have two approaches to social impact for the assets that we manage. Much revolves around engaging with the people in our buildings to support charities through stalls, bake sales and so on, but we also work with partner charities by providing meeting room space for free. Our focus on the people who use our buildings means that we provide great amenities and facilities in our office buildings, but we also incorporate enhanced worker welfare provision in our industrial refurbishments.”
Bjorn Hobart, Investment Director of Tritax Big Box REIT, said: “With ESG at the centre of all investment decisions, we aim to develop and own logistics real estate that delivers net positive impacts through cutting edge, sustainable design, investment and asset management. Moreover, in 2022, we revised our net zero carbon targets to bring them forward by a decade to 2040. These targets hold us to account, and we disclose our performance publicly.
“Our strategy is comprised of four key pillars: how we invest, how we manage, how we add value and how we innovate. This means that we ensure that new buildings are all built to a minimum industry standard of EPC Grade A. We also actively engage our customers to understand their needs and create places that support both their building and wider wellbeing needs, delivering jobs and wider societal value. For example, for every square foot we build, 10p goes to local projects and groups.”
Opportunities, challenges and outlook
Laura Elkin, Portfolio Manager of AEW UK REIT (AEWU), said: “AEWU exploits what it believes to be the compelling relative value opportunities offered by pricing inefficiencies in smaller commercial properties let on shorter occupational leases in strong commercial locations. This core strategy is supplemented by active asset management initiatives to improve the quality of income streams and maximise value.
“Volatile markets can present significant opportunities for an actively managed value strategy such as that of AEWU. Following a number of timely disposals which helped maximise the values of key assets during the summer of 2022, the company has seen an increase in attractive opportunities in its investment pipeline due to less competition from other buyers leading to a greater availability of mispriced assets. Being unconstrained by sector means the company’s strategy can identify value across all areas of the UK real estate market.”
Richard Shepherd-Cross, Fund Manager of Custodian Property Income REIT, said: “The challenge is access to capital. The opportunity is normally at its greatest in a downturn. Our focus is less on investing in the acquisition of new properties, but on investing in our existing portfolio through targeted capital expenditure which both enhances environmental performance and improves or adds to cash flow. Current examples include PV installation, office and industrial refurbishment, and acquisition of adjoining interests combined with sales to special purchasers to deliver outperformance against holding values.”
Jason Baggaley, Fund Manager, abrdn Property Income Trust (API), said: “The investment company structure makes it easier to manage the portfolio in a difficult macro environment due to its fixed capital structure. Every decision we make is made because we think it is in shareholders’ best interests. This is a very challenging market environment and I believe that we need to be patient, focusing on delivering value in the medium term by doing the basics well – I am very fortunate to have a great asset management team on API driving income generation.”
Nick Montgomery, Fund Manager of Schroder Real Estate Investment Trust, said: “Despite dampened investor sentiment for real estate and the impact that higher interest rates have had on values, for managers with the active management expertise, there continue to be opportunities to deliver attractive rental and capital growth in sectors such as higher yielding regional industrial estates, as well as higher yielding retail warehousing and offices in stronger regional centres. The rapid repricing witnessed in certain sectors and growing pool of forced sellers should also offer select earnings accretive buying opportunities.”
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Notes to editors
- Based on open-ended funds and investment companies investing directly in UK property (not in property securities). Source: theaic.co.uk / Morningstar (as at 30/09/23).
- The Association of Investment Companies (AIC) represents a broad range of closed-ended investment companies, incorporating investment trusts and other closed-ended investment companies and VCTs. The AIC’s members believe that the industry is best served if it is united and speaks with one voice. The AIC’s vision is for investment companies to be understood and considered by every investor. The AIC has 345 members and the industry has total assets of approximately £262 billion.
- For more information about the AIC and investment companies, visit the AIC’s website.
- Disclaimer: The information contained in this press release does not constitute investment advice or personal recommendation and it is not an invitation or inducement to engage in investment activity. You should seek independent financial and, if appropriate, legal advice as to the suitability of any investment decision. Past performance is not a guide to future performance. The value of investment company shares, and the income from them, can fall as well as rise. You may not get back the full amount invested and, in some cases, nothing at all.
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