In praise of sheds

Warehouses may have fallen from favour, but they’re still essential, writes David Prosser.

As financial advisers consider client asset allocation models for the year ahead, real estate offers up a dilemma. On the one hand, last year was pretty dismal for this asset class, particularly in the UK, where residential property prices fell, and the FTSE 350 Real Estate Index racked up its worst performance for more than 15 years.

On the other, the prospect of lower interest rates to come in 2024, particularly if the Bank of England is able to move more quickly than expected, could provide a tailwind for recovery; the market already seems to have bounced a little since the low points seen last October.

One way to resolve this dilemma could be to focus on an area of the real estate market that has suffered very mixed fortunes of late. The Property – UK Logistics sector shot the lights out in 2020 and (particularly) 2021, had an utterly dismal 2022 and finished last year up 19.4%.

The rollercoaster ride has a lot to do with the path of interest rates, but the pandemic was another factor that focused investors’ attention on the e-commerce story. That story fell from favour as shopping habits normalised and rates rose, and bearish comments from Amazon on its intentions around property did not help.

However, sheds, as the property sector likes to describe warehousing, are set to remain an essential part of the economy for years to come. Data from Savills suggests that while demand for warehousing space was lower last year than in 2021 and 2022, it was still higher than in any previous year. Vacancy rates in the warehousing sector now stand at lower levels than prior to the pandemic. And demand for e-commerce, which drives retailers’ need for sheds, is forecast to continue increasing in the years ahead.

Against this backdrop, sector analysts such as Colliers point to growing investor interest in sheds, both in the UK and further afield. Professional investors, including in the private equity sector, continue to take a keen interest in a broad range of these assets.

In which case, the investment companies sector could offer real value as a way into this type of asset. Shares in each of the three UK Logistics investment companies – Tritax Big Box, Urban Logistics and Warehouse REIT – currently trade at chunky discounts to the value of their underlying assets. Advisers buying into these funds today will be doing so at an average discount of just over 15%.

Also, all three funds are set up as real estate investment trusts (REITs), which offers tax advantages. To qualify for REIT status, a company must own and rent out commercial or residential property, and it must distribute 90% of the profits it makes from this business to shareholders. REITs do not pay corporation tax on their profits – and investors are liable for income tax, rather than dividend tax, on the distributions they receive.

That’s particularly useful because such investment income won’t count against investors’ dividend tax allowances, now steadily shrinking. Plus, of course, these funds can be held inside an individual savings account (ISA), which means there is no tax at all to pay on either income or capital gains.

None of which is to suggests that sheds are a slam dunk for 2024. And it’s also worth looking at overseas funds in this space (even though they won’t normally have UK REIT status). Still, for advisers looking for a way back into real estate, logistics could be a good start – and investment companies are an accessible means through which to access the market.