Investment Trusts

Pan European Real Estate: why it’s still ok to own this asset class

May 2020
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Risk Disclaimer 

Capital is at risk. The value of an investment is dependent on the supply and demand for the trust’s shares rather than its underlying assets. The value of the investment will not be the same as the value of the trust’s underlying assets.

Past performance should not be seen as an indication of future performance. Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned.

The market value of the shares of TR Property may not reflect the underlying net asset value of the investments held by TR Property. If markets fall, gearing can magnify the negative impact on performance.

Pan European real estate markets have suffered along with almost every other sector imaginable as the coronavirus pandemic continues to threaten health systems and disrupt social and working norms around the world. Both the TR Property Investment Trust and its benchmark are down for the year to end-March 2020, although it’s of course worth noting that the trust has again outperformed the benchmark, now for the ninth year in a row. However, we would of course be happier if the numbers did not have a negative sign in front of them.

 

Risk Disclaimer

Capital is at risk. The value of an investment is dependent on the supply and demand for the trust’s shares rather than its underlying assets. The value of the investment will not be the same as the value of the trust’s underlying assets.

 

Source info: TR Property Investment Trust as at 31 March 2020

Putting these performance figures aside, we believe it’s still ok to own (most of) this asset class for now. There are two key reasons at play here: fundamentals and valuation.

 
Fundamentals

Firstly, yields remain substantial compared with those in fixed income and other income alternatives. And secondly, while rental growth has taken a step back, we expect tenant demand to remain stable overall in many of the trust’s key markets. What’s crucial is maintaining a tightness in supply – and the prospect of a deferred development cycle as developers’ appetite for risk waivers will be welcomed.

 
Valuation

Share prices are very much forecasting muted earnings growth across the property board, with a likely outright collapse in the retail sub-sector. Meanwhile, debt costs will reduce even further as money gets cheaper owing to the ongoing state and central bank intervention.

 
Our equity portfolio

The sell-off in pan European real estate equities has been rational from a sub-sector perspective. The market fell in rather an organised fashion, with the sectors you would expect being hit the hardest: consumer-facing areas such as Retail, Hotels and Leisure. Meanwhile, UK Student Housing suffered largely from Unite’s decision to waive students’ rent. Elsewhere, UK Healthcare and German Residential are trading close to or at pre-COVID levels.

Our positioning in the TR Property Investment Trust was beneficial here, being long both German Residential and UK Healthcare, and underweight European Shopping Centres. Meanwhile, our long UK Retail exposure is reflected solely in our position in recent star performer Supermarket Income REIT and (as touched on above) we expect to see a V-shape recovery in UK Student Housing – a sector we are also long in – when universities reopen. Hotels are only a tiny part of our world, where we don’t have much exposure at all.

 
The physical property portfolio

Our physical property portfolio (currently 8% of the Trust’s net assets) increased in value during H2, owing to asset management initiatives. In Bristol, we agreed a new 10-year lease to UK delivery service company Yodel at a 47% increase on the previous passing rent, as well as receiving planning permission from Wandsworth Borough Council for a multi-use scheme on a current industrial site, which will increase the gross external area more than fourfold.

In terms of the Q2 rent roll, we collected 78% of rent within a couple of weeks of the quarter day. 17% has been deferred to monthly payments – of which we received April and May’s payment from all – and we expect to be unable to receive the remaining 5%, an obvious candidate here being our gym operator.

 
Outlook

It’s hard to quantify the full impact of the pandemic but we do think there are some things we can be certain about. The cost of money will remain low for a long time, meaning long and strong income streams will persevere – the tenants likely to survive or even thrive on the bumpy post-corona recovery road are the names to keep on owning.

We expect ongoing dispersion in sector performance, with positive returns in the Residential, Healthcare and Logistics sectors, and negative performance across Retail, Hotels, Leisure and Serviced Offices. Geographically, much will depend on the level of state support small and medium-sized businesses get as cash flow will be crucial.

Valuation differentials will remain based on sub-sector exposure, followed by income reliability. What we are currently seeing is a cashflow demand strike, not a balance sheet crisis like the 2008 GFC – and the banks are not the villain this time. Although we have seen some boards panic and withhold cash owed to shareholders, we expect this to calm down; meanwhile, other boards have been much more understanding about their different stakeholders adjusting dividends partially.

Finally, a note on the dividend. Full-year results will be announced on 29 May, and while we’re not sure what the board will decide to do, the Trust does have a history of a relatively full payout ratio. As an indication, H2 revenue was almost exactly in line with forecasts and although Landsec’s cancellation of its third interim dividend after trading ex-dividend was very disappointing, its overall impact is small. Importantly, the trust has built up revenue reserves over a long period of time, and this may well be the kind of crisis scenario in which to use those reserves.

Past performance should not be seen as an indication of future performance. Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned.

The market value of the shares of TR Property may not reflect the underlying net asset value of the investments held by TR Property. If markets fall, gearing can magnify the negative impact on performance.

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