09 Mar 2023
Marcus Phayre-Mudge, Manager, TR Property Investment Trust
After multi-year central bank support, through QE, came to an end last year and an extended period of record low interest rates was reversed in response to stubbornly persistent inflation, real estate equities fell 37% (source European Public Real Estate Association as at 31.12.22) and finished the year as the poorest performing GIC sector.
On the global stage, 2022 ended with heightened worries about energy prices in Europe, a ‘hot’ labour market driving inflation higher in the United States and China, a global engine of manufacturing and consumer demand, still waging a lockdown war with Covid.
Within the space of just a couple of months, things have shifted and the view out to 2023 looks just that little bit brighter. Inflation has not gone away but there are tentative signs that it may be at or near its peak and that is good news for interest rates and investors in property. Even this small shift in sentiment is significant and calendar-year-to date1 real estate equities are now registering a gain of about 12% (source Bloomberg as at 15.3.23)
The pick-up in confidence in our sector has been supported by the combination of a more benign economic backdrop (a warmer winter in Europe plus successful gas stockpiling, and China out of lockdown without the widespread sweep of infections many had feared) and medium to long-term supply constraints within the physical property sector.
In the case of the latter, we are witnessing a rather unusual development this cycle. Both yields and rents are rising in tandem. Normally, we would expect the rising cost of borrowing to restrict the capacity of landlords to achieve higher rents. This is not happening due to a shortage in the supply of property that renters most want.
On the supply front, finance for new construction projects was already challenged by the risk averse environment that followed 2008’s global financial crisis and Brexit uncertainty. The Covid-19 pandemic further narrowed the pipeline as investors deferred commitment to large projects. In particular, this has resulted in a shortfall in prime real estate that meets the growing corporate ‘green’ agenda.
This reality is repeated in every major city be it London, Paris, Madrid or Berlin. Office occupiers want to be in the best locations and in buildings that are highly energy efficient. A green building super cycle will be required to meet demand. Until then, prime assets can capture strong indexation advantages.
From a consumer point of view, covid piggy banks are still feeding holidays (good for hotels), eating out (retail) and experiences (leisure). These savings are burning out, however. We can already see that in low-income families where the cost-of-living is having a harsh impact and we are not optimistic on the outlook for retail rents. However, yields in this sector are already high.
In terms of any new investments, our criteria are strict; not too much debt (loan-to-value ratio capped around 30%), debt fixed for 3-5yrs and an ability to capture indexation. If these characteristics can be met, the returns should fare favourably to other indexed assets such as inflation-linked bonds.
On this basis, we have recently added to Great Portland Estates (prime central London office developer aligned to the momentum gathering green building super cycle), increased our holding in the UK diversified REIT Picton (c.60% industrial/20% retail/20% offices), who are keen to act as sector consolidators, and introduced a position in our sister fund, CT Property Trust (to which we relate at arms-length) on attractive valuation grounds.
On the disposal side, we have reduced our exposure to UK healthcare (rental growth is constrained to below indexation and the underlying operators’ margins are struggling due to labour costs /shortages). We have also moved increasingly underweight, relative to the benchmark, in German residential. While this cohort of companies enjoys excellent occupancy rates (there is such a shortage of flats), for some, their debt profiles rely on refinancing large bond issuances in the next two years at much higher rates.
1 12 months to 15 February 2023.
Risk Disclaimer
The value of an investment is dependent on the supply and demand for the shares of the Investment Trust rather than its underlying assets. The value of an investment will not be the same as the value of the Investment Trust’s underlying assets.
The value of directly held property and property related securities reflect the opinion of valuers and is reviewed periodically. These assets can also be illiquid and significant or persistent redemptions may require the manager to sell properties at a lower market value adversely affecting the value of your investment.
Views and opinions have been arrived at by Columbia Threadneedle Investments and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned.