Empty retail units, offices with barely a soul around, falling rental income and property funds suspended. After the last 18 months, who would want to invest in property?
The property sector, with its mix of residential and commercial, is notoriously cyclical, the classic boom and bust story. However, the last year and a half has read like a chapter all of its own. The UK property sector as a whole took a significant hit in 2020, with property across retail, hotels, tourism and leisure severely affected. Offices were also hit although to a lesser extent. In contrast, property in other sectors has remained remarkably buoyant. Chief among these are distribution and warehousing, and data centres.
Despite an initial collapse in the housing market in May last year, the housing sector has staged a strong recovery , with house prices 13.4% higher in June 2021 than 12 months earlier, according to Nationwide. Investors in the sector didn’t get away unscathed, with the value of property-related shares and funds with exposure to the sector plummeting in the early part of 2020. Investors relying on the shares of Britain’s house builders for income also saw their dividends slashed, with most house builders suspending dividends and clawing back planned returns from shareholders. Open-ended property funds found themselves in particular trouble, with a number suspended as investors rushed to sell their holdings (more on this later). Although a number of funds did manage to reopen, even as late as the end of October last year a total of £5.2bn worth of UK property funds remained suspended, leaving investors uncertain as to if and when they would get their money back.
With all this going on, and a number of Courtiers Funds holding Property assets, no better time then to speak to Matt Parker, Equity Analyst specialising in real estate.
Q: Matt, given all the problems in the sector over the last year and a half or so, as a fund manager what still makes Property an attractive asset for Courtiers?
Matt: Property is an asset class just like anything else. So investing in it yields diversifications benefits in just the same way as investing across different sectors and different asset classes, such as conventional equities and fixed income.
What I would say about Property is that there are specific benefits, particularly favourable tax treatment for REITs (Real Estate Investment Trusts) that make them attractive for investors. Property is also income generative because often there is an income stream from tenants, which in turn generates a stream of income for shareholders. Property is also a hedge against inflation – in times of rising prices, it tends to hold or increase its value.
Q: How has the Property Sector been affected by the pandemic?
Matt: It caused a lot of disruption in the sector. You had cooling rent collections, particularly in areas like retail, leisure and hotels, and gyms. And then there was a general reduction in transactions across the market leading to less liquidity in the market in general, which meant that valuing property was difficult. In the case of retail to which we have a fair amount of exposure, this has added to the structural decline in footfall that we have seen in the High Street, and shopping malls, which has led some people to argue that it has accelerated the trend away from the High Street.
Q: What were the effects of this on valuations in the sector?
Matt: Ultimately, this led to a lot of uncertainty. The way property is valued is that a yield is applied to the net operating income of the assets, and if the level of uncertainty and risk rises this increases the yield. This in turn decreases the overall value of the asset.
Q: What has been happening more recently?
Matt: Although it’s been patchy, there has definitely been a bit of a recovery. There is increasing evidence of what those in the Property sector call ‘yield compression’, which means that the yield is coming down and the capital values are rising. We have seen this particularly in out-of-town retail parks, which became a lot more attractive during the pandemic. In general because they are bigger sites there is more potential for social distancing and tenants are better able to put measures in place to reassure the public and to keep them safe. I am hopeful that as the lockdown unwinds we will see similar yield compression in those other assets in the High Street and in shopping malls.
Q: What about the office market to which Courtiers Funds have some exposure?
Most of our exposure is prime City and West End space in London, which we hold through Land Securities, a diversified REIT in a number of our funds (see table below for a detailed breakdown). Although the office sector has been somewhat affected, rent collections have been fairly robust. Since then rent collection rates have improved, with Land Securities achieving nearly 100% for its offices in financial year 2021. Now that people are starting to go back to their offices we might expect rent collection rates across the office sector generally to be even stronger. That said, I have seen conflicting evidence on whether people are going back or not. Overall, in terms of Courtiers exposure, I would say the office sector has been fairly robust.
Q: It is noticeable that although Courtiers Funds hold a range of Property assets, it doesn’t hold them in open-ended funds (OEICS). Could you explain the reason for that, please?
Matt: The problem with open-ended funds is that when an investor wants to sell out of such a fund, the fund has to either liquidate the assets or to raise the cash to pay that investor. The issue with Property funds and open-ended structures is that property is inherently illiquid – it can take months to sell properties, and so if the fund doesn’t have sufficient cash, or there is a run on the fund and loads of investors want to redeem immediately, the fund may not be able to meet the demands of investors who want to sell out.
Q: That’s exactly what happened last year, isn’t it?
Matt: Yes that’s right. Under FCA legislation introduced at the end of 2019, where the value of 20% or more of the assets of a fund is uncertain then the fund may have to suspend trading. That’s what happened in March 2020. A lot of property funds didn’t reopen until this year. Others, such as Aviva decided to wind up three of its property funds having never reopened, a decision soon followed by Aegon Asset Management. So that’s the reason we don’t hold any direct exposure to open-ended Property funds in our multi-asset or Equity funds, which is why we have managed to avoid any of these problems.
Q: I notice that much of Courtiers exposure to property is through REITs. Can you explain, what a REIT (Real Estate Investment Trust) is and why as a fund manager Courtiers favours them?
REITs give us all the benefits of a closed-ended structure, but in addition they have a very favourable tax status in that they are exempt from corporation tax if more than 90% of their property rental income is distributed to shareholders. This also creates an income stream for their shareholders. So that’s why we hold a number of REITS – Hammerson, New River and Land Securities (see below for breakdown across Courtiers Funds). We also hold BMO Commercial Property Trust, which since June 2019 has been part of the UK REIT regime.
Q: It’s a bit of an outlier compared to other Courtiers holdings, but you also have a position in LSL Property Services, a UK-based property services firm. Why?
Matt: This company met all our criteria, and after falling sharply last year its share price has rebounded strongly in the last 12 months. It makes up 3.1% of our UK Equity Fund, and since we bought into the company in July 2017, it has returned 85.32%, (as of 16/7/21) including dividends.
Q: You’ve talked about the UK, but what about the international Property market?
Matt: We hold some overseas exposure via Hammerson, all over Europe, including Continental Europe and the Republic of Ireland. Broadly, I would say the lockdowns in different countries have had a similar effect. Where the UK differs is in the growth of online shopping, which means there’s been strong demand for distribution and logistics centres. In contrast in countries such as the Netherlands and Italy online penetration has been much lower.
Q: Housing has remained remarkably bullish. Why is this, and how long do you expect this to continue?
Matt: Yes, the housing market and house prices have done very well during the pandemic with a lot of transactions and mortgage advances at their highest level since the end of 2007. The extension of the Help-to-Buy Scheme certainly helped and its replacement by a new equity loan scheme, which is more focused on first-time buyers. So, although the stamp duty holiday is coming to an end, we are still quite bullish on the housing market, which is why we continue to hold both Persimmon and Taylor Wimpey in our UK Equity Fund, (2.84% and 2.59% respectively). They have been selected with a value lens on them, and in normal times at least they both pay a decent dividend. Since we purchased them in November 2015, our holdings in Persimmon have returned 127.91%, while Taylor Wimpey, which we bought in July 2017 has returned 4.91% (both figures as of 16/7/21 include dividends).
Breakdown of Property Holdings across Courtiers Funds as of 19 July 2021