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Darius McDermott: Are property funds back to their best?

Last year’s dip was a strong confirmation of property’s long-term value

Darius-McDermott-700x450.jpgLast July, property was the topic on everyone’s lips. I must have taken at least 50 calls in one week from clients and journalists as the asset class fell out of favour and funds suspended trading. Then, a much quieter murmur when they re-opened in October.

The story has been on the backburner ever since. But in that time, the share prices of major UK property trusts like British Land and Land Securities have quietly returned to trade around pre-Brexit levels. Many of the re-opened funds have also gradually risen this year, although I would not say they have all necessarily “recovered”.

So, should we be reconsidering the role of property in a portfolio as Brexit negotiations begin? There are a few different aspects to consider.

Property did what it was “supposed” to do

The way I see it, last year’s dip was in some ways a strong confirmation of property’s long-term value. Property funds are typically added to a portfolio for two main reasons. The first is to provide an income and, even while suspended, open-ended funds continued to pay distributions. On the trust front, British Land and Land Securities both increased their dividend per share for the 2016/17 financial year.

Which commercial property funds were worst hit in the wake of Brexit?

Secondly, property is held as a diversifier; in that it will ideally demonstrate a low correlation with other asset classes. It is also important to keep in mind the nature of the investment vehicle: property funds essentially hold an asset class that is illiquid through an asset class that needs liquidity. They naturally have different risks to other equity or bond funds.

Who is leaving London?

That said, the main concern now is the outlook for the UK commercial sector. Big companies are nervous about where to headquarter. If Britain comes out of the single market, office spaces in London could free up pretty fast. Property values would come under pressure and the city could be in for a difficult few years.

On the other hand, some longer-term, underlying trends are ticking along regardless of political and macro risks. One example is the move towards internet shopping. Companies are expanding warehouses to service online orders, making industrial property a potential growth space, even as some retail centres may start to flag. Hospitality (gyms, hotels and so on) has also become an area of interest for opportunities outside of office buildings.

Henderson UK Property has a nice sector spread across retail, office, industrial and alternatives, which includes leisure. If you do subscribe to the view that an allocation to property remains sensible for the long term, this is a fund I think spreads risk well, with long lease lengths, low vacancy rates and income from around 500 tenants across 120-odd buildings.

What about in Europe?

Another option for property investors is to look across the channel. Generally, 2017 has been a better year for Europe than we have seen in a while. Unemployment has fallen, inflation and GDP growth have improved and, following the French and Dutch elections, there is perhaps a bit more political stability. The main risk is probably that quantitative easing has inflated asset prices. Although the European Central Bank is not winding down yet, it eventually must, and this may cause volatility.

At a more granular level, though, specific parts of the European market may appeal. Manager of Premier Pan European Property Alex Ross currently has around 20 per cent of his fund in German residential. He says house prices there are lower than the cost of building a new home, which has kept supply very low. Germans have traditionally preferred to rent but are now being forced to buy due to increasing shortage of rental properties. Ross predicts strong capital growth as supply is squeezed.

Trusts or Oeics?

A final question that always comes up around property is whether to buy through trusts or Oeics. The shorter-term pros and cons of each vehicle were aptly demonstrated by the sell-off period last July. And while retail investors might instinctively feel that Reits were a better bet because they did not “trap” people’s money, it is worth reminding clients that those who were prevented from panic selling out of Oeics may have since seen prices stabilise. So, in some ways, these investors may have been helped to prevent potential losses.

Over the longer term, it can be interesting to compare an Oeic and a trust run by the same team, such as F&C Real Estate Securities and TR Property Investment Trust. Marcus Phayre-Mudge leads the two portfolios, many of whose holdings overlap. Leverage makes the trust more volatile and has contributed to quite significant periods of under and outperformance versus the fund, although total returns from both have been strong since F&C Real Estate Securities launched in 2010.

Darius McDermott is managing director at Chelsea Financial Services

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