TR Property

Pan European property equities continued to travel in the tight (10%) trading range seen since March. Market fundamentals remain robust in many of our sub-sectors, and indexation (rents rising with interest rates) continues to assist in driving top-line growth, energising those with a more positive outlook on prospects from here. However, the macroeconomic overlay successfully supresses this operational soundness with continuing concerns around the possibility of further central bank hawkish behaviour (such as indicating that they will keep interest rates higher for longer). Mid-October saw a bout of pessimism compounded by geopolitics and another conflict (with the oil price pushing upwards). This was followed by more dovish (accommodative) commentary from the US Federal Reserve (Fed). The mid-month low point of -7% (1 October to 25 October) was followed by a dramatic recovery that has continued into November. The monthly statistics were, therefore, -3.0% for the net asset value (NAV) and -3.1% for the benchmark, with the share price slightly weaker at -4.8%.

Switzerland’s property companies were the top performers, with the two largest (PSP Swiss (+3.2%)) and Swiss Prime Site (+0.5%)) reminding investors that inflation remains very subdued. The expectation following the Fed and the Bank of England’s October commentaries is that, while we may well be close to this cycle’s ‘peak rate’, rates are predicted to remain broadly at current levels for some time. The weakest performance was generally among those companies continuing to have challenging balance sheets, with investors now focussing on refinancings required out in 2025 and beyond. Stock performance was, therefore, bottom-up driven, with a large range of moves in each jurisdiction.

In the UK, the worst performers were all small caps across several sectors. In offices, CLS (-27%), which owns assets in the southeast of the UK, Germany, and France, had a torrid time. The founding family control over 50% and have been adding to their position. In European logistics, Eurobox (-10.4%) and Aberdeen European Logistics Income (-18.5%) both suffered. While they are both externally managed, Abrdn owns 60% of Tritax, which manages Eurobox, so it would make commercial sense to amalgamate and offer shareholders the benefit of scale through lower fees. Life Science REIT (-11.8%) has struggled to convince investors that enough of its assets can warrant a premium rent. Leasing at its flagship Oxford Technology Park will be a useful indicator. Meanwhile, those with the best balance sheets (i.e. the least debt), such as UK Commercial Property (-0.75%) and NewRiver Retail (-2.4%), were much steadier performers. Picton (-4.8%) is our preferred ‘best-in-class balance sheet’ name, with a lower-than-average loan-to-value and mostly fixed until 2031. It announced the successful change of use from office to residential of its largest asset. In our view, this is a game changer for the valuation of this portfolio given the negative sentiment towards offices requiring significant future capital expenditure.

Self-storage was a classic example of a broad range of returns, with performance entirely stock focussed. Safestore (-7.1%) revealed slowing performance metrics alongside the announcement of the retirement of the well-regarded Chief Financial Officer. Meanwhile, Big Yellow (+1.8%) took the opportunity to raise £108m (at a small discount to the undisturbed share price) to complete the next wave of developments and enjoyed a much stronger month.

In Sweden, monthly returns ranged from SBB (-19.1%) to Corem (+18.7%); the latter announced a series of large portfolio sales that were taken positively given the scale of the company’s indebtedness and the highly discounted price. SBB, on the other hand, is still seen as having very little net equity. The third-quarter reporting season added to our conviction that those names with little near-term refinancings will continue to deliver earnings growth, given the indexation applied to existing lease contracts. We have added to our holdings in Castellum and Balder.

In Germany, LEG (-10%) had a poor month, while TEG (+3.5%) enjoyed the news that Moody’s has maintained its Baa1 rating with a stable outlook. We are overweight in TEG and underweight in LEG. Our preferred holding, Phoenix Spree Deutschland (owner of high-quality Berlin residential), has steadily increased the number of apartments for sale. Given that the shares are trading at more than a 60% discount to the NAV, there is considerable room for management to sell assets below book value while still being accretive to shareholders.

At our industrial estate in Gloucester, we have entered into a new lease with Infusion GB, a tea-packaging business and existing tenant on the estate, for unit 2. The company is taking a new eight year lease at a rent 34% ahead of the previous passing rent. This clearly provides positive support for future rental growth.

The Trust’s interim report and dividend for the six months to 30 September will be published on 23 November.

Discrete rolling annual performance as at 31.10.2023 (%):

	2023	2022	2021	2020	2019
Fund	-3.7	-32.5	33.9	-12.2	15.8
Benchmark	-5.4	-34.6	27.5	-16.1	11.4
Share Price	-9.5	-33.6	44.4	-18.6	15.5

The steady recovery in real estate equity prices from mid-August to mid-September was aided by the collective growing belief that we were in the final stages of the interest rate-rising cycle for US and European central banks. Inflation numbers were slowing which indicated a slowdown in consumer spending. This was all very encouraging for an asset class such as real estate whose performance is heavily influenced by the cost of borrowing. However, in the last two weeks of September and continuing into October, the backdrop shifted again. The oil price has risen (pushed up by cuts in production) and bond yields have climbed once again as prices fell.  They reached levels not seen since before the global financial crisis in 2008. It is not surprising that our benchmark (the FTSE EPRA Nareit Developed Europe Total Return (in sterling terms)) has fallen -7% between 14 September and 3 October.

Over the month, the net asset value (NAV) fell -2.7%, slightly underperforming the benchmark, which fell -2.4%. The share-price performance was slightly better at -1.6%. All of this negative performance occurred in the last 10 days of the month. Given the backdrop, it was no surprise that Sweden (-7%) was the worst-performing country due to its domestic property companies having higher exposure to borrowing. Equally, the best region was the traditional safe haven of Switzerland, where the inflation data was encouragingly subdued. At the heart of this negativity is a concern that, even if rates have peaked they will stay higher for longer. The issue for many (but not all) property companies is that their cost of debt will rise as they refinance their debt obligations from much lower levels. These higher interest bills will impact earnings that the businesses are able to generate if their ability to grow the rents they generate on properties they own is not maintained. And this is a key point for more cautiously minded investors. We are consistently hearing that, operationally, businesses are sound, with little default from their tenants in terms of paying rent, steady renewals on expiring leases and little expansion in buildings becoming empty. In fact, in the case of industrials, logistics, student accommodation and high quality and well located  (new) Central Business District (CBD) offices, rents are rising. However, there are clearly some markets where tenants are under pressure and are cutting costs where possible. We have seen weakness in business customer levels at the major self-storage operators, with Big Yellow falling -12.7% and Safestore down -14.9% during the month. These are dramatic price movements, but it should be noted that these are names that had previously enjoyed being priced at a premium and effectively, they have given some of that back. For the vast majority of listed property companies, their shares continue to trade at historically wide discounts to the underlying value of their assets, and this forms a key part of our investment thesis.

Lower quality offices and older buildings requiring significant capital expenditure to ensure they comply with energy-efficiency regulations continue to be under (justifiably) huge pressure. Regional REIT (never owned by the Trust) fell -34.1% during the month as it announced another cut in the dividend. Its leverage (exposure to borrowing) remains unsustainably high and there is pressure to make sales of properties it owns (into a weak market). This is a concerning negative feedback loop and investors rushed for the exit.

Ediston, the retail warehouse specialist where the Trust owns 16% of the equity, completed the sale of its entire portfolio to Realty Income (a $36bn US REIT), and we expect the cash to be returned in January following the formality of the sale process. In the meantime, the dividend of 7% will continue to be paid monthly.

The Trust’s physical property portfolio is independently valued six monthly, and the interim September valuation was £72.45m, a decline of -4% over six months. This equates to 7.5% of net assets of the Trust. The Trust’s overall interim performance figures (31 March to 30 September) saw a NAV total return of +3.3% against a benchmark of -0.8% and a share-price total return of 4.5%.

Discrete rolling annual performance as at 31.10.2023 (%):

	2023	2022	2021	2020	2019
Fund	-3.7	-32.5	33.9	-12.2	15.8
Benchmark	-5.4	-34.6	27.5	-16.1	11.4
Share Price	-9.5	-33.6	44.4	-18.6	15.5