February 2021

Real estate equities had a difficult month, as rising bond rates and fears of reflation pushed investors away. Our view remains firm: for sectors where there is little oversupply, then the demand created by economic reflation is most welcome. Simply put, not all real estate is equal, and we remain focused on asset types that will enjoy rental and capital growth as economic conditions improve. We remain overweight fundamentally sound markets, such as German residential, industrial/logistics across Europe and the UK, smaller office markets (e.g. German and Nordic cities) and self-storage. We favour index-linked income, where earnings will grow if inflation does appear. The vast majority of our companies have taken advantage of very low interest rates, managing to extend duration while also reducing their overall cost of debt. These businesses are eager for the government stimulus to feed through into real economic growth.

In the short run, markets have focused not on fundamentals but on the opportunity to make fast money in the rallies seen in the most discounted property names – retail and hospitality. Compounding this rotation has been the market’s determination to buy domestic UK names, which has helped UK property stocks hugely (almost regardless of fundamentals). Year to date, EPRA UK has returned 0.6% (in sterling) versus continental Europe at -6.5% (in euros). Given our more fundamental approach, we are pleased to have matched the benchmark return in February (-2.9%), while the share price fell a little less at -1.7%. Looking at the attribution, it is clear that the decision to close the collective underweight to European shopping centres at the end of last year was correct, while the failure to do the same in the UK has been costly. We now hold some Hammerson (+12.6%) and Capco (+21.2%), but not Shaftesbury (+10.5%) or New River Retail (+18.4%). The underperformance of index-linked income with longer-term capital growth – exemplified by Vonovia (‑4.3%) and LEG (-4.4%) – appears linked to the self-fulfilling fallacy that these assets should have a strong correlation to bonds. The ongoing underperformance of these high-quality businesses means that they are now trading at 15%+ discounts to their net asset values (NAVs) at the end of 2021. These discounts are now wider than the equivalent metric for Landsec (+9.1%) and British Land (+9.1%), based on our expectation of the end-of-year NAVs (March 2022) for those companies. Given the structural risks to their retail assets, this looks unsustainable. We remain confident that residential values across Europe will continue to rise as governments seek to stimulate their economies through house price inflation and banks can make excellent margins on the ‘free’ money they are being offered. One only has to review the UK budget announcement to see the stimulus process in action.

Corporate activity, like the weather, is warming up. In our sector, we have had capital raises in half a dozen names in the last month, with more in the pipeline. Also announced this week is the first initial public offering in over two years, from CTP, a Central European logistics owner/developer, which is seeking to raise €1 billion of primary issuance. The Trust has so far participated in Cofinimmo (Belgian healthcare/office business), Xior (Belgian/Dutch healthcare) and EuroBox (European logistics).

In the interim report, I commented on the underpin of privatisation – if public markets undervalue listed property companies then private equity will step in. RDI REIT (market cap £465 million) announced an agreed deal for Starwood to buy the 70% it doesn’t already own at 122p, a 30% premium to the undisturbed share price, but well below the last published NAV of c.150p. This is an important transaction. It bursts the myth that boards need to achieve asset value. Instead, they need to ask the question, ‘when will our business trade at the discount to asset value being offered by the buyer’. The problem for these small, listed companies (market capitalisation below £1 billion) is that they lack economies of scale (leading to subscale operating margins) and that, simultaneously, the shares lack liquidity. The writing is on the wall – they need to merge or get taken private. The last two mergers in the sector, LondonMetric/Mucklow and PHP/Medicx, have highlighted the value of improved operating margin and share liquidity.

Discrete rolling annual performance as at 26.02.2021 (%):

	2017	2018	2019	2020	2021
Fund	15.88	12.84	7.12	16.06	-4.60
Benchmark	14.36	7.80	3.37	11.39	-7.59
Share Price	13.08	26.13	5.05	17.94	-9.62