19th November 2021
Our funds’ allocation to property has mostly been to a very targeted bunch of REITs that provide exposure to a particular part of the market that has structural growth tailwinds. The choice available for investors has grown significantly in recent years meaning we can pretty much gain access to anything we want, such as care homes, supermarkets, logistics warehouses or Berlin residential property.
The latest addition to the universe (and our three funds) is a Life Sciences REIT that has acquired assets that are, or soon will be, tailored for companies operating within the life science industry and all will be close to the UK’s top science universities in London, Oxford and Cambridge. The innovation and new companies spawned from these universities is up there with the best in the world, yet the number of suitable properties in the UK is less than those in the US city of Boston. Another classic example of a niche sub-sector with very strong supply-demand dynamics that should help underpin strong income and capital returns for investors.
These new targeted REITs have understandably attracted billions of pounds from investors like us with most now trading on premiums to net asset values (NAV). In contrast, traditional generalist REITs, i.e. those that are designed to be a one-stop-shop for investors to gain exposure to a diversified mix of properties across the main three sectors, offices, industrial and retail, have lost their appeal judging by their share prices which, by and large, are currently trading at discounts to NAV. In the past week or so, we caught up with a couple of these REITs, BMO Real Estate Investment and Standard Life Property Income Trust, to see if there is an investment opportunity, and to pick their brains on what is going on in the market. Without going into the details of each mandate and portfolio, a common attraction is that both REITs are managed by UK-based managers who are backed by a well-resourced team of property managers around the world that can identify long-term trends within sectors. This is crucial for a diversified multi-sector REIT as it takes time and costs a lot of money to make an asset allocation switch in property (unlike a UK equity manager, for example, that can buy and sell a few shares very quickly and cheaply), so being early onto a trend is important. Outsourcing property exposure to diversified REITs like these have merits for investors who don’t have the time or expertise to analyse the dynamics of each sub-sector themselves, or perhaps more importantly don’t switch exposures once a sector has become too expensive into another where there is better value. For example, a manager of a REIT that only invests in supermarkets will continue to buy them even as yields compress further (values become more expensive) because that’s the mandate and they can’t buy anything else. Most of the targeted REITs have seen their yields compress from around 6% a couple of years ago to yields beginning with 4% now reflecting strong demand as bond yields have fallen towards zero. Generalist managers may be choosing to move on from these assets to invest in the next attractive sector. It seems that retail warehouses/parks (the ones slightly out of town with Halfords, Pets at Home, The Range and B&M) are the ‘next big thing’ where yields of 8% are possible. Generalist managers have the ability to move the portfolio around within their REIT, while investors in a range of targeted REITs need to do it themselves.
Assessing the quality of a generalist REIT’s underlying portfolio is of course paramount, both at a sector level and in terms of individual assets. A number of generalists have been steadily reducing exposure to high street retail and other troubled sectors and now have portfolios that are heavily biased to those areas enjoying secular growth. A quick sum-of-the-parts discount analysis suggests the market has missed, or is not interested in this transition, which potentially presents a contrarian value opportunity for investors.
Regardless of how the FCA’s review of the open-ended property funds concludes, there is a great opportunity for the generalists REITs to be considered as a suitable alternative. The benefits of the closed-ended structure when investing in illiquid asset classes like property (no cash dilution, no flow-driven forced selling or buying of assets etc.) combined with the modest use of gearing has helped generalist REITs deliver superior yields and better total returns than their open-ended peers over the years, and should therefore be firmly on retail and other investor’s radars. If they can sort out platform availability then there should be a decent increase in demand coming. That, as well as investors like us wondering when the time might be to jump off winning targeted REITs trading on ever keener yields onto a well-managed, diversified generalist REIT, could provide technical support and see their anomalous discounts to NAV narrow. We don’t think that time is now, but we are monitoring the situation carefully.
Daniel Lockyer – Senior Fund Manager
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