June 2019

Pan-European real estate equities suffered a poor month, with the FTSE EPRA Nareit Developed Europe Capped Index in sterling falling -1.73%. The net asset value (NAV) total return of the Trust fell slightly less at -1.48%, delivering a modest outperformance of +25 basis points.

Against the recent trend, it was continental Europe (-3.5% in euros) that fared much more poorly than the UK (+0.3% in sterling). The primary culprit was the sharp correction in German residential names (ranging from -3% to -25%) following the news on 6 June 2019 of a potential 5-year rent freeze (‘Mietendeckel’) in Berlin. The bill still has to be passed in October; the majority of legal experts consider the bill, proposed by Berlin’s state government, to be unconstitutional because: (i) the state government lacks legal competence, i.e. such laws can only be passed at the federal level; and (ii) such a law would be an undue and severe infringement on property owners’ rights. However, the market is now pricing in a high probability that it will become law, but will then be followed by a multi-year appeal process.

The largest listed German residential landlord Vonovia (the Trust’s largest holding) fell -10.6%, despite having only 10% exposure to Berlin. Similarly LEG Immobilien’s portfolio is 100% located in North Rhine-Westphalia (with zero Berlin exposure), yet its shares declined -7.2%. At present, we do not share concerns about spillover risks due to the unique situation in Berlin, where the left-leaning local government is determined to take extreme measures to solve the housing crisis – 85% of the population live in rented accommodation and rents have soared 80% over 10 years on the back of strong net migration flows into the city.

Our only (relative) overweight position in Berlin is to a small cap stock, Phoenix Spree Deutschland, which is best placed, in our view, to adapt to this changing market environment. It is nimble (2,500 units compared to 118,000 units for listed peer Deutsche Wohnen) and enjoys a strong balance sheet (with a loan-to-value ratio of 27%). The company could quickly transition its business model towards condominium privatisation sales, thereby extracting high margins. Indeed, the current -32% NAV discount implies capital values significantly below cost of replacement, as well as achievable selling prices. Finally, management is well aligned with close to 10% ownership. We therefore feel that the ‑19.4% correction in the month has been too aggressive and presents a buying opportunity.

Thematic retail divergence continued in June, with logistics landlords outperforming shopping centres. We do not foresee a trend reversal, given the diametrically opposed operational outlook for the two sectors. Our small cap logistics names performed well in June, with Swedish investor/developer Catena, the sector’s top performer, delivering +11.5%, while Argan in France returned +8.9%. This compares to shopping centre names, such as Intu (-17.7%). NewRiver Retail (-12.6%), meanwhile, has been caught up in the Woodford saga, with Neil Woodford still owning over 12% of the company.

We participated modestly (due to heavy scale back on orders) in the initial public offering of John Mattson, a focused affordable housing landlord in Stockholm, which returned +27% in June. We believe that the listing provided strong support for our other Swedish residential small cap, Hembla, which was up +5.6% over the month.

The Annual General Meeting will be held on 23 July 2019 at 2.30pm at the RAC, 89 Pall Mall, London SW1Y 5HS.

Discrete rolling annual performance as at 28.06.2019 (%):