We all remember traditional property funds falling from favour after the EU referendum when certain open-ended vehicles were forced to gate after investors pulled their cash out, but Reits also suffered a sharp move to hefty discounts.
At the end of June 2016, the Association of Investment Companies (AIC) Property Direct UK sector dropped to a discount of -12.19%, having been at -1.16% the month before.
But these discounts swung to a premium of 5.62% at the end of May 2017 before dipping to a -0.41% discount at the end of February as Brexit fear took hold once more.
Despite the valuations rollercoaster in the sector, AIC communications director Annabel Brodie-Smith says there has been a steady demand for property investment companies, including Reits, from wealth managers and advisers since the Brexit vote.
Immediately after the referendum, the Property Direct – UK was the industry body’s most popular sector. Indeed, in Q3 2016 it accounted for 15% of purchases via platforms. Last year, the the AIC’s property sector dominated in terms of new issues, accounting for 56% of the assets raised (£1.4bn of the £2.5bn total) and eight out of 15 new issues.
Brodie-Smith says: “After the Brexit vote demand for property investment companies bounced back swiftly and so did their share price performance.
“The closed-ended structure comes into its own over the long-term when investors can sit out the inevitable economic wobbles and their impact on the commercial property sector. Investment company managers do not have to worry about inflows of hot money and outflows when times are tough and buyers are hard to find, but can concentrate solely on the long-term performance of the portfolio.”
Buying opportunity
But more recently interest rate rises and the continuing uncertainty around Brexit have seen Reits get pushed further into discount territory, particularly as the UK retail and office space has been hit, and some wealth managers have spied an opportunity.
AJ Bell recently upped Reit exposure in its three lowest risk portfolios to 8% having taken money out of equities. It uses the iShares Property ETF, which seeks to track the performance of an index of the UK’s 38 largest commercial property companies.
Ryan Hughes, head of fund selection at AJ Bell Investments, says Reits are appealing based on the longer term argument that property is a good diversifier and the shorter term valuation opportunity presented by the discount because of the uncertainty around Brexit.
“That has led to Reits underperforming and being quite volatile and offering up a valuation opportunity that over time may be attractive,” he says.
“Of course, if economic issues build and Brexit becomes more uncomfortable it is entirely possible those discounts could widen, but from a long-term basis, on a five to 10-year view, and the shorter tactical one to three-year view; marry those together I think you can see attractive characteristics.”
Direct is best
Some, including Ben Yearsley, director at Shore Financial Planning, prefer to use direct property for the simple and long-held belief that it brings diversification to the portfolio.
“I think Reits and property shares are too closely correlated to equity markets over the shorter term to provide that diversification,” he says. “With advisory clients I think it’s more about building long-term portfolios rather than trying to time parts of the market.”
But, Yearsley adds: “Having said that, if the discounts were wide enough I’d certainly look at funds that invest in Reits.”
AJ Bell’s Hughes accepts that over the short term an element of equity correlation is to be expected, but he believes that is the trade-off for having liquidity in property exposure.
“The alternative is to buy the funds that own the physical and we know the dangers that can bring from a liquidity perspective,” he says. “But over the long term, five to 10 years, that diversifying characteristic comes through.”
Hughes says AJ Bell has no physical property exposure across any of its portfolios.
Index value
Like Hughes, WH Ireland research analyst John Goodall prefers to buy the index rather than individual stocks in the Reit space. As such, the WH Ireland portfolios have an 8.5% exposure to property, split between the F&C Commercial Property Trust and the iShares MSCI Target UK Real Estate.
“If you pick up the Reits, there is such a big discount to the NAV you are getting a margin for error which looks decent,” says Goodall. “The downside is maybe the asset values are overstated a bit, but I would suggest a lot of that is in the price.”
He adds: “We wanted to be doing something the index is doing and doing more of it because we think it does represent value.”
While not exposed to individual Reit stocks, Goodall can see certain names in the distribution and logistics sector continuing to do well. The likes of FTSE 250-listed London Metric and Tritax Big Box are on his radar because they are benefitting from the growth in online commerce and are trading closer to par than other names with bigger discounts.
“That is another way to play it, but you are not getting such deep value in those instances,” he adds.
However, Goodall says stocks like this can be too focused on one sector and some of the criticism with Tritax, for example, is despite operating in what is currently the right sector, it has paid high valuations for some assets.
“We are quite keen but it is riskier because it is one stock,” he says. “When you are buying the fund you are getting exposure to the market.”
That said, he believes London Metric could be of interest for the right client.
Ignore NAV
But for Rogier Quirijns, portfolio manager and head of European research at Cohen & Steers, looking at the premium or discount to net asset value is a mug’s game. Rather than be lured by big discounts he says wealth managers should look for trusts that offer income, as well as good growth prospects and strong management.
Quirijns cites some of the more established Reits such as New River, a favourite of Neil Woodford, as a value trap because of the big discounts and because it is in the wrong sector.
He says: “You need to be cautious here. I still think there are too many people looking only at NAV and not at the growth of income. Those investors who look at a sector and think it is cheap because of NAV need to be really cautious about what they buy.
“I know stocks that trade at a 50-60% premium to NAV and they are great stocks to have great income, 4-5% dividend yield, and no reason to ever sell. Warehouses de Pauw, a Belgian stock – every UK wealth manager should look at that.
“I think the private wealth sector should be very focused on income, so buying a discount is a mistake.”
