Background
Unless you’ve been in a cupboard for the last month or so you will be aware that property funds have taken a beating since the surprise result of the EU referendum in June.
By 6 July, more than £14bn was ‘locked in’ to open ended property funds through a variety of mechanisms (gating/exit charges etc) and the average discount in the closed ended UK property sector – which had until that point been trading mainly on a premium – had plunged to below 16%.
Discounts have recovered since then – the sector at the start of this week was trading at an average of around 5%. But there has been much soul-searching about the future of open ended property funds. As in 2008, they have been forced into a deeply uncomfortable position where they are effectively preventing unitholders from cashing out.
This position, critics argue, undermines the credibility of the structure itself as appropriate for this type of investment, where underlying assets are illiquid. Forcing managers to hold cash on the way up (in case of redemptions) creates cash drag in positive phases, while forced sales on the way down during negative periods destroys performance.
It is true that investment trusts are, by design, better able to cope with illiquid investments. However, rather than arguing the toss over the merits of one structure versus the other, here we highlight a number of trusts which, for different reasons, we think are worth a closer look at this interesting and uncertain time for the sector.
DISCOUNTS SINCE THE REFERENDUM
Source: Morningstar.
*Statistics for Primary Health Properties & Industrial Multi-Property trusts have been disregarded on the grounds that they have nothing in common with their peers.
Outlook
Property valuations are very much evidence based. Given that closed end fund portfolios are valued quarterly, NAVs are at this stage unlikely to reflect the (as yet unknown) impact of the Brexit vote. Most likely, Q3 NAV announcements during September / October will be the first time valuers will have had an opportunity to property reflect transactions agreed or completed with the full facts of Brexit known.
However, whilst the true impact on NAVs is not yet knowable, the impact on share prices may be speculated upon. Cross shareholdings and ownership of listed funds by open-ended property funds was a key driver behind the collapse of closed-end property funds in 2008, when share prices fell by around 70% with discounts yawning to 50% as open ended funds dumped stock on the market. A recent study by Bloomberg, found that among the stricken open-ended funds there is a degree of mutual exposure which could add to the woes of those invested in them. M&G, for example, owns more than two million shares in Aviva’s suspended fund, while Standard Life holds around 2.4 million shares in M&G’s fund. However, it doesn’t look like they have a significant exposure to listed funds, which will prevent too much cross contamination. According to Numis’ Charles Cade, who produced an excellent review of the sector earlier this month, shareholder registers are in far better shape this time around, with ‘far fewer distressed sellers’ on the books.
Balance sheets, too, are better than they were in 2008 according to Charles’ research. Debt levels today are around the 30% LTV (loan-to-value) mark, as opposed to 50% back then, and the average lease within property portfolios is over five years – meaning yields have some degree of security at least for the medium term.
Against this backdrop, the relative health of closed-end property funds is clear, and with strong yields and well covered dividends on offer, we think this is an interesting time to examine the sector.
Funds in focus
As an addendum to this study, we examine three closed ended property funds in more detail. Empiric Student Property, yielding 4.9% via quarterly dividends, offers differentiated exposure to property returns which are not correlated to the main economic cycle. It is not cheap, on a premium of 5.2% at the time of writing, but with concerns mounting about Britain’s ability to attract students from overseas in the aftermath of Brexit we may well see that premium dwindle.
Click here to read more about this trust
Picton Property Income, yielding 4.8% with a well-covered quarterly dividend, has been hit hard in the aftermath of Brexit by its higher gearing, and perhaps a perceived exposure to London offices. It now sits on a discount of more than 10% – at one point having plumbed 25% earlier this month.
Closer examination of the portfolio, however, shows that the type of properties it holds are not those which are first in the firing line when it comes to multi-nationals shutting up shop and relocating to Frankfurt, instead focusing on smaller, cheaper London offices outside the main City/West End hotspots.
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Standard Life’s UK Commercial Property Trust is the final trust in our review. The trust is due to publish its interim results this week and, yielding 4.8% via a near fully covered dividend, it sits on a discount of 5%. With low gearing and a portfolio which is well diversified in terms of the type of property it holds and the regions to which it is exposed, the trust is one of the more conservative vehicles offering mainstream exposure in this asset class.
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