TR Property

While our benchmark returned a modestly positive figure for the month of +1.4%, behind this was a rollercoaster of performance. The sector fell over 9% in the first two weeks of October amid a continuation of the pegging down that commenced in mid-August, just ahead of the Jackson Hole symposium and the acceleration of central banks’ hawkish responses. The sector correction from 13 August to 13 October was a severe -30%. However, the sector then rallied +11.5% into month-end. This resurgence looks set to continue into November as investors attempt to guess the point at which central banks will ‘pivot’, slowing their aggressive policy responses to rampant inflation.

We believe that now is not the time for stock picking. Property fundamentals are taking a backseat and price action is being dominated by the relative security of any given stock’s balance sheet. Those with the greatest leverage and sensitivity to interest rates are suffering (or enjoying) the greatest volatility. Swedish property companies, which had fallen -36% from the August highs, saw a sharp 15% rally in the last two weeks. The poster child for volatility remains the Swedish social infrastructure owner, SBB, with a published loan-to-value ratio of 46% (but much higher, circa 62%, when hybrids and other exotic instruments are taken into account). Its 27% rally from the October low has continued into November; it is the most shorted stock in our universe and these bear squeezes are very aggressive. Our underweight position in Sweden (which aided relative performance during September) delivered negative alpha in the October rally. While the Trust has gearing (circa 12%), the impact of this needs to consider our physical property portfolio (circa 8% of net assets) to correctly reflect the effective gearing in the equity portfolio. Investors may be surprised to see that we have any gearing (after adjusting for the physical portfolio), but this provides some compensation given our large number of lower beta small cap companies that tend to be left behind in the initial stages of any sustained rally in share prices. In fact, our net asset value total return in October of +1.0% lagged the benchmark (+1.4%), despite the additional (modest) gearing. The relatively poor performance of our good quality small caps such as Phoenix Spree Deutschland illustrates the situation. This specialist owner of Berlin residential (market cap £242m) fell -9% in the month. In Spain, Arima (market cap £214m), the Madrid office developer, fell -3%. In the UK, our longstanding multi let industrial specialist, Industrials REIT, fell -4%, and our newest small cap, a deep value UK diversified name, CT Property Trust (market cap £168m), fell -10%. These four companies have below average leverage, and none have material debt refinancing requirements.

Our standout performer was Klepierre (+13.7%), which, alongside Eurocommercial (+9.3%), comprises the bulk of our Continental European retail exposure. Given the higher starting yields (when compared to logistics or CBD offices), these shopping centre owners are expected to have smaller capital value adjustments. They are also among a very small handful of property companies that have had a positive total return over the year to date.

We continue to pay close attention to the pricing of listed property companies’ bonds. Not only does this help us to assess the likely cost of refinancing, but it is also a useful indicator of sentiment towards balance sheet strength across multiple jurisdictions. Our central case remains rooted in the expectation that central banks are not changing their hawkish stances in the short term. The need to reduce inflationary pressures is overwhelming. However, our sector remains highly correlated, with sentiment around a change in the rate curve, and we will need to respond quickly to any sustained change in market expectation.

The Trust’s interim results for the six months to 30 September will be published on 5 December and will include the interim dividend.

Discrete rolling annual performance as at 31.10.2022 (%):

	2022	2021	2020	2019	2018
Fund	-32.51	33.92	-12.20	15.79	6.59
Benchmark	-34.60	27.54	-16.13	11.42	3.10
Share Price	-33.62	44.42	-18.58	15.49	11.03

Real estate was the worst performing GICS sector in September. Inflation data continues to print higher figures, encouraging central banks to react more hawkishly as they seek to control the demand-driven inflationary stimulus. Unfortunately, that control mechanism has little impact on energy costs, which are one of the key drivers of this inflationary surge. Over the course of the month, investors became increasingly concerned about the trajectory of base rates and the impact on funding costs. Moreover, politics also played a part in investor worries, with the well-documented fiasco of the UK government’s ‘mini-budget’. At the beginning of the month, markets were pricing a peak base rate in the UK of around 4%. This shot up to 6% in the aftermath of the politically driven uncertainty. The negative impact on sterling makes matters worse. The UK imports a lot more than it exports, and devaluation pushes up import prices. The sterling devaluation may also increase the persistence of inflation once the peak has passed.

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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.

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Global risk assets reversed some of their year-to-date negative performance. Bond yields fell over the month, with investors believing that central banks’ hawkish responses are likely to have a deflationary impact. Unsurprisingly, Pan European real estate equities had a very strong month, with the Trust’s benchmark returning + 9.5%. The same index, when viewed in euros, rose +12.4%.

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A difficult May was followed by a terrible June for real estate equities. Investors decided that inflation hadn’t peaked (a hope in May) and that central banks’ policy response would be more aggressive than previously expected as they seek to bring inflation under control. The result was a rapid widening in bond spreads (the difference in yields between different bonds), a steepening of the front end of the yield curve (a widening of the spread between short and long-term bonds) and the pricing-in of a consumer driven recession as mortgage costs rise despite high levels of employment. Our benchmark, FTSE EPRA/NAREIT Developed Europe (total returns, in sterling terms) fell -14.8% and the net asset value fell -15.0%. The bright spot was the share price, which was down ‘only’ -7.2%.

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