28th May 2021
Property as an asset class has been filling the column inches again in the past few weeks. Firstly we’ve seen a number of open-ended property funds that shuttered last March finally reopen, sparking significant redemptions as long suffering unit holders take advantage of the opportunity to take back control of their hard earned cash.
On a related point we have also had the announcement that one such vehicle is set to close its doors forever, citing structural value and liquidity concerns. The Financial Conduct Authority have been weighing in of late as well with its consultation on so called Long Term Asset Funds (LTAFs). This consultation seeks to explore ways in which less liquid assets (like bricks and mortar property) can be held within an open-ended fund structure whilst not compromising investor protections. We would argue that the correct structure for owning illiquid assets already exists – it is called an investment trust and has been around for many years. We have written extensively on the pitfalls of accessing property via daily dealing open-ended funds (including this 2019 article) and do not intend to revisit or twist the knife further in this blog.
Our motivation for discussing property today comes from a much more positive place and one that reflects recent market action where we are seeing lots of demand for, and strong price action in, many of the Real Estate Investment Trusts (REITs) we own in the Funds. When considering our property exposure we think about what each individual holding brings in terms of risk and return, and recognise that different investments within the asset class can play very different portfolio roles. As such our property exposure can be thought of as fitting into one or more of three distinct areas.
The first area of focus is on property sub-sectors that enjoy attractive and sustainable supply-demand dynamics. Investments here include Urban Logistics which owns last mile logistics warehouses, where the boom in ecommerce is driving increased demand for these assets. This has resulted in rental growth and upward revaluations. Another would be a longstanding play on the extremely tight Berlin residential market where a growing population and lack of new build apartments underpins strong rental growth. These are long standing positions enjoying strong structural tailwinds.
The second area we focus on is REITs that operate in non-cyclical areas, where we have a high degree of confidence in the stability of cash flows that support stated return targets. Investments in supported social housing which enjoy government backed, inflation-linked cash flows fit the bill here. Another example is our investment in Supermarket Income REIT, which benefits from very long index-linked leases with blue chip counterparties whose underlying business models have little sensitivity to the economic cycle. We often refer to these types of REIT as ‘bond proxies’, attracted to their typically low equity correlation and c.5% dividends, which look particularly attractive in the context of painfully low government and corporate bond yields.
Our use of investment trusts to access property, and the existence of targeted REITs operating in niche areas, has allowed us to pursue this very granular approach which has benefitted Fund performance for several years. Historically we have eschewed generalist property funds. After all, who wants to own retail parks and high street shops given the secular difficulties facing those particular sectors? The pandemic-induced volatility of last year however threw up a number of interesting opportunities to buy REITs with temporarily disrupted but fundamentally decent assets on frankly ridiculous discounts to net asset value (NAV). As valuation-conscious investors who seek to own investments which possess a margin of safety, it would have been remiss of us not to look at some of these opportunities. After much analysis and due diligence we began selectively building positions in a number of these distressed REITs which make up our third area of focus. For example, a mixed sector, London-centric portfolio of super prime assets was picked up on a close to 50% discount to NAV. Similarly, we invested in a REIT with theme park and pub exposure but also rock solid healthcare assets at a point where the prevailing discount was ascribing close to zero value to the sectors impacted by Covid.
The interesting thing about the past few weeks is that almost all of our REITs have been performing strongly. The reopening of economies as the vaccine roll-out gathers pace has seen our distressed REITs materially re-rate. These were always trading positions and we have been trimming positions and crystallising gains (c.40% in some cases) as the value opportunity becomes less compelling. Some upside in a couple of names remains however, and we continue to harvest returns in this space.
The yield pickup offered by our bond proxy REITs over and above mainstream fixed income has always felt somewhat anomalous to us and in the face of the recent rise in bond yields and resulting capital losses, it seems the market has come round to our way of thinking. Many of our ‘dull and boring’ REITs have been bid up in the past few months to trade on material premiums to NAV, but continue to deliver very attractive risk adjusted yields. The fact that many of these have index-linked leases is of further appeal at a time when inflation fears dominate many an investor’s list of concerns.
Finally our backing of REITs operating in structurally growing areas continues to reap rewards. Results from one logistics focused REIT earlier this week revealed a 28% NAV total return in the year to 31st March 2021 – an absolutely stellar outcome in what has been an undoubtedly difficult year.
Highly targeted exposure to property has been an important component of our Funds for years, providing attractive stand-alone returns and portfolio diversification benefits alike. Recent months have been particularly strong for our REIT investments but with our flexible and unconstrained approach, our extensive experience and use of investment trusts, and our focus on value we remain confident in identifying and accessing the best opportunities in the sector. Coming full circle, and perhaps twisting the knife just a little, it might also be the case that the probable demise of open-ended property funds and subsequent outflows add further impetus to the success of our REITs in the weeks and month ahead.
Ben Mackie – Fund Manager
This financial promotion is issued by Hawksmoor Fund Managers which is a trading name of Hawksmoor Investment Management (“Hawksmoor”). Hawksmoor is authorised and regulated by the Financial Conduct Authority. Hawksmoor’s registered office is 2nd Floor Stratus House, Emperor Way, Exeter Business Park, Exeter, Devon EX1 3QS. Company Number: 6307442. This document does not constitute an offer or invitation to any person, nor should its content be interpreted as investment or tax advice for which you should consult your financial adviser and/or accountant. The information and opinions it contains have been compiled or arrived at from sources believed to be reliable at the time and are given in good faith, but no representation is made as to their accuracy, completeness or correctness. Any opinion expressed in this document, whether in general or both on the performance of individual securities and in a wider economic context, represents the views of Hawksmoor at the time of preparation and may be subject to change. Past performance is not a guide to future performance. The value of an investment and any income from it can fall as well as rise as a result of market and currency fluctuations. You may not get back the amount you originally invested. HA4336.