The outlook for rates continued to dictate price action in August. The market narrative shifted during the month from inflation peaking to persistently high inflation. The hawkish signals from Jackson Hole have reset rate path expectations higher and removed the likelihood of a central bank pivot.
Against this backdrop, Pan European property equities (FTSE EPRA Nareit Developed Europe (total returns, in sterling terms)) returned -7.9%, underperforming broader equities (STOXX Europe 600 Index (net total returns, in euro terms, -5.05%)). Over the first half of the month, the sector held up relatively well as bond yields were broadly unchanged. However, they started their vertical ascent from 15 August 2022. For example, the 10-year Bund rose +72 basis points (bps) to 1.52%, while the 10-year Gilt closed the month at 2.8% (+94bps). The Trust’s monthly performance was in line with the benchmark falling -7.7%, while the share price fell a little further to -9.6%.
Swiss property companies were strong relative performers in August (-2.2%) and they may be seen as a relative safe haven less exposed to soaring bond yields. Indeed, the Swiss government 2 year-7 year yield curve ranges between 0.7% and 1.0%. This is due to Swiss inflation running +3.5%, which is ‘low’ by today’s European standards. This exerts less pressure on the Swiss National Bank to take restrictive monetary policy actions.
The largest European property company, German residential landlord Vonovia, reported solid operational results. However, investors are solely focused on balance sheet deleveraging following the company’s late cycle acquisition of Deutsche Wohnen in 2021, which pushed the loan-to-value ratio to uncomfortable levels. The company earmarked 66,000 flats valued at €13bn for disposal. While management remains confident of selling these at book values, the market awaits actual transactional evidence given the volatile debt funding environment for prospective acquirers. The stock returned -16.8% in the month.
Self-storage companies performed relatively well (-4.8%) as the demand for space remains robust and the sector has demonstrated its resilience during past economic contractions. The second quarter reporting season continued to provide relatively robust earnings data throughout August. Following its absence for many years, the return of inflation translated into an instant boost to rental growth, especially on the Continent, where leases are substantially linked to consumer price inflation.
At the earnings level, this positive impact outweighs the lagged negative impact from rising interest rates because the sector benefits from a high proportion of fixed or hedged debt. We estimate that 73% of the sector aggregate debt is fixed or hedged for an average duration of 5.8 years. However, investors remain rigidly focused on the balance sheet metrics as the rising cost of equity begins to be priced into net asset values. We feel that the market has indeed now factored in significant valuation adjustments, with the sector trading collectively at a 30-35% discount to the last reported values.
The weakest regions were the UK (-10.2%) and Germany (-14.8%), with the latter dominated by residential stocks. The UK saw its highly rated logistics and industrial companies suffer from an expectation of yields widening from their current low levels. While the rental growth expectations baked into these valuations remain appropriate, the initial yields below 4% do not. Segro fell -13.9%, Tritax Big Box fell -15.6% and LondonMetric fell -13.2%. Due to the long-term structural tailwinds, we are monitoring these companies closely.
Given the scale of the discounts (share price to asset value), we welcome the buyback strategies (made following asset sales, not increased gearing), which are highly accretive. We are also pleased to see that Industrials REIT, a large holding of ours, has entered the FTSE All-Share Index following its change of domicile from South Africa to the UK. Its entire portfolio of multi-let industrial property is now in the UK, following its three-year transition from a Pan European, diversified portfolio.
Discrete rolling annual performance as at 31.08.2023 (%):
Performance data is in GBP £ terms. Investors should be aware that past performance should not be considered a guide to future performance. All fund performance data is net of all fees and expenses.