With current political uncertainty, persistently low interest rates and high street store closures soaring, many investors’ eyes are on property. But what are investment companies’ views on the sector and what does the future hold for this asset class?
With Brexit hanging in the balance, a general election now weeks away, persistently low interest rates and high street store closures soaring, many investors’ eyes are on property. But what are investment companies’ views on the sector and what does the future hold for this asset class?
With assets totalling £15.9bn, investment companies investing directly in property make up a large part of the investment company industry. Across the five sectors investing directly in property, these companies give investors access to a considerable variety of different property types, ranging from offices and shopping malls to supermarkets, social housing and warehouses.
On Tuesday 5 November the Association of Investment Companies (AIC) held a media lunch with managers from the Property – UK Commercial sector. Peter Lowe, Manager of BMO Real Estate Investments, and Will Fulton, Manager of UK Commercial Property REIT, discussed their investment strategies and the outlook for the sector. Their thoughts have been compiled alongside comments from Stephen Inglis, CEO of London & Scottish Property Investment Management Limited, the asset manager of Regional REIT.
At £10.7bn, the Property – UK Commercial sector accounts for more than half (67%) of direct property-focused assets under management. The sector, with an average yield of 5.1%, may also be attractive to income-seeking investors in the current low interest-rate environment, and investment companies in this sector now stand at an average 1% discount.
Annabel Brodie-Smith, Communications Director of the Association of Investment Companies, said: “The closed-ended structure of investment companies makes them particularly well suited to investing in hard-to-sell assets such as property. This was highlighted by the differing fortunes of open-ended and closed-ended property funds following the EU referendum in 2016. Despite discounts widening, closed-ended property companies continued to trade, with their managers able to take a long-term view of the market, whilst their open-ended counterparts were forced to suspend due to high outflows.
“The fact that investment company managers don’t need to worry about meeting redemptions means that property-focused companies can hold less cash than open-ended property funds, resulting in more money being invested and put to work for the end investor. During low-interest rate periods, investment companies provide a structurally sound vehicle through which investors can access this illiquid asset class, providing attractive levels of income and the prospect of long-term capital growth.”
What impact is the political uncertainty and Brexit having on UK property?
Peter Lowe, Manager of BMO Real Estate Investments, said: “The impasse at Westminster and the prospect of a change of government is destabilising for the market. The UK is a vibrant, capable economy with a skilled workforce and many comparative strengths, but the continued delays have paralysed business and are adversely impacting the economy.
“The most immediate impact of the continued uncertainty on the real estate market is the collapse in transaction volumes which have fallen sharply and are now below long-term averages. While there will be continued near-term disruption and the potential for ongoing volatility in markets, the sector is in relatively good health and offers much for the medium-term investor. There is plenty to like about UK real estate, not least the yield premium, income growth in most sectors outside of retail, good levels of occupancy for quality stock and a relative absence of typical ‘late cycle’ behaviour in the lending and development space.”
Stephen Inglis, CEO of London & Scottish Property Investment Management Limited, the asset manager of Regional REIT, said: “Brexit uncertainty is providing buying opportunities for experienced asset managers who are able to methodically identify the most suitable assets where their unique skills can best be deployed. The future is still uncertain but we have seen office letting continue to perform well in the regions. We anticipate that any negative impact will disproportionately impact the prime markets and London specifically, neither of which we invest in.”
Will Fulton, Manager of UK Commercial Property REIT, said: “The likely path that Brexit negotiations can take remains extremely complex. The subsequent uncertainty created is largely being reflected through a more subdued investment market for UK real estate, with year to date investment volumes down 27% on the same period last year. Investment activity has been largely skewed towards the industrial and alternative sectors where income streams are typically more durable and defensive. Moving forward I would expect investment market activity to remain subdued, at least until more clarity is provided from a political perspective.”
What’s your investment strategy?
Will Fulton, Manager of UK Commercial Property REIT, said: “Our investment process is underpinned by a wide, research-based view of the market and our deep-seated stock-picking expertise, enabling us to identify the right buildings in good locations and in sectors experiencing tailwinds. For example, the long-term structural changes are being driven by ecommerce, physical improvements to infrastructure or the wider built environment (transportation and public realm) which we believe will enhance future value and grow rental income. All of this is enabled by our strong balance sheet. UK Commercial Property REIT has one of the lowest gearing ratios in its peer group in the range of approximately 16% (to 22% fully invested) and with £85 million available to deploy in new opportunities. The portfolio is heavily weighted towards the best-performing market segments and is diversified by occupier, geography and sector.”
Stephen Inglis, CEO of London & Scottish Property Investment Management Limited, the asset manager of Regional REIT, said: “Put simply our strategy is to invest in quality office and industrial assets in the major regions of the UK outside the M25 to generate high income for our shareholders. This income is paid through quarterly dividend distributions, currently offering a high dividend yield of 7.9%.”
What sort of property do you invest in?
Peter Lowe, Manager of BMO Real Estate Investments, said: “Property fundamentals come first. We seek robust residuals with significant value in the real estate rather than simply the lease contract, and an absolute focus on the occupational underwrite. Over the last few years I have positioned the portfolio to lean more towards the industrial market, which now accounts for over 40% of current assets by value, and the office sector. These positions have been made predominantly via sales from the retail portfolio, where the smaller average lot size of the company portfolio has preserved some liquidity in a testing market, and reallocation of proceeds to other projects.”
Stephen Inglis, CEO of London & Scottish Property Investment Management Limited, the asset manager of Regional REIT, said: “We acquire high-quality, income-producing, predominantly office and industrial properties across the UK regions.
“A good example is 800 Aztec West, a 73.292 sq. ft. office building in Bristol’s premier business park. Following significant asset management activities, the building is now 100% let with EDF and the Secretary of State for Defence as anchor tenants. The property was acquired for £6m in January 2016 and now has a market value of £18.4m.”
Will Fulton, Manager of UK Commercial Property REIT, said: “In 2015, we proactively undertook to reposition the portfolio and build an overweight position in the industrial and logistics sector (now 48% of the portfolio), while materially reducing our exposure to retail. Proceeds from the strategic disposal of, for example, two shopping centres were reinvested into assets benefitting from longer-term, positive structural trends. These included a large industrial estate on the M25 at Radlett, which has grown significantly in value and the development funding of a new ‘pre-let’ hotel in Newcastle with a 35-year index-linked lease. Other examples are an office in Reading which had been fully refurbished at a cost of £16 million before we acquired it and benefits from a dynamic tech-led occupier market, itself about to have a step-change in infrastructural transport connections when the Elizabeth-Crossrail line is switched on, and one of the UK’s most successful cinemas in the heart of Glasgow, also on a long lease with built in fixed rental increases.”
What’s your outlook for the property sector?
Stephen Inglis, CEO of London & Scottish Property Investment Management Limited, the asset manager of Regional REIT, said: “Uncertainty will always provide risk and opportunity, though going forward these may be less discernible than at present, which may result in many regrets for those not taking action. We have extensive experience in dealing with similar assets through the 2008-2012 downturn where the valuations fell but income was maintained. In fact, the income was increased by 3% over that period, reflecting the resilience of the UK core and core plus regional office and industrial markets.”
Will Fulton, Manager of UK Commercial Property REIT, said: “Our outlook for UK real estate is being shaped by the current political backdrop and as such, we continue to favour sectors that provide more durable and defensive income qualities. In spite of the uncertainty facing businesses, the occupational market is generally stable with the exception of the retail sector which faces its own structural challenges. Performance for this sector will be more challenging as a result.
“The industrial sector remains one of our favoured sector calls, which is largely due to the strength of the occupational market. Robust levels of rental growth in London, the South East and the best urban locations across the UK are a clear illustration of this. In addition, we see selective opportunities arising in the alternative sectors and expect interest in more operational sectors, which provide greater exposure to the underlying performance of income-generating assets, to increase going forward.”
Peter Lowe, Manager of BMO Real Estate Investments, said: “The market is slowing. Whilst we expect single digit positive total returns at the all-property level, sector and stock selection can significantly improve prospects. Income return will drive performance and the preservation of income will be vital. Lower interest rates for longer could provide additional support for the property market, with long leases and secure income seen as a favourable alternative to gilts.”
What are the benefits of investing in property with investment companies?
Peter Lowe, Manager of BMO Real Estate Investments, said: “For the longer-term investor, the most obvious benefit has been the performance, with investment companies having delivered attractive relative returns against some alternative structures. Using an investment company structure to hold real estate means investors can benefit from a higher exposure to the asset class itself, as investment companies can take advantage of gearing and the reduced requirement to hold higher levels of cash. With income being the bedrock of real estate returns over any extended time scale, the ability to employ prudent levels of gearing has allowed managers to enhance returns. This has been particularly true over the last few years given the yield on real estate and the comparative cost of debt.”
Will Fulton, Manager of UK Commercial Property REIT, said: “As an investment trust, a REIT is a public limited company and a closed-end fund which can offer particular benefits to real estate investors. For example, a REIT doesn’t need to liquidate holdings to return money to shareholders. Instead, its shares can be sold (and bought) at any time on the stock market. This means there’s no delay for shareholders who want to sell. Because assets don’t need to be liquidated to redeem shares, a REIT doesn’t need to hold large amounts of cash. So more of its capital can be invested in property – plus the manager never has to be a forced seller of any of their holdings at a sub-optimal price.
“Unlike other types of investment funds, investment trusts can also borrow money to invest to boost potential returns. Every investment trust also has a board of directors that’s independent of the investment team to ensure the trust is being managed in the best interests of its shareholders. These shareholders have the right to receive an annual report and attend and vote at the trust’s annual general meeting, giving them an active say in how their fund is managed.”
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- The Association of Investment Companies (AIC) was founded in 1932 to represent the interests of the investment trust industry – the oldest form of collective investment. Today, the 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 mission statement is to help members add value for shareholders over the longer term. The AIC has 362 members and the industry has total assets of approximately £198 billion.
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