Pan European property equities (FTSE EPRA Nareit Developed Europe total returns, in sterling terms) returned -3.1% and underperformed broader equities, which were almost flat during May but demonstrated significant intra-month volatility. The Trust’s net asset value (NAV) fell slightly less at -2.9% but the share price was hit harder and fell -7.7% over the month. This pushed the discount to NAV out to -9%.
Inflation data remained stubbornly high, and the market re-assessed its dual impact on listed property companies; this is a negative as it accelerates the rising interest rate cycle and complicates the companies’ access to funding but is also helpful for rental growth, in particular for genuine consumer price index-hedged income streams such as supermarkets. This inflation data also enables a faster capture of embedded rent reversion in sectors like logistics.
The listed real estate sector has repriced significantly this year (-12.8% year-to-date, total returns, in sterling terms). Residential, once the largest sub-sector and often seen as the ultimate bond proxy, returned -25% over the year to date. The depressed collective valuation (-40% NAV discount, 7.1% earnings per share yield and 5.1% dividend yield) reflects concerns around rent affordability (household income squeeze), cost inflation and relatively high leverage due to large late-cycle acquisitions from three of our German names: TAG, LEG and Vonovia. We think that, in order to enable a re-rating, these companies need to regain their capital allocation credentials by accelerating disposals, thereby proving values and reducing leverage. We also need to see a normalisation of the bond market (where real estate spreads have widened significantly), yet with little sign of stabilisation. All told, we added to our sub-sector overweight as we consider this under-valuation excessive. Importantly, our largest overweight in the residential space, the Berlin specialist Phoenix Spree, has returned -10.9% over the year-to-date, which is far less than the other German companies.
In May, the worst performing sector was logistics. This followed Amazon’s late April statement that it is no longer chasing physical capacity. Although this comment was mostly related to the US, where Amazon’s warehouse footprint is four times larger than in Europe, it sent pan-European European logistics players down -15% (including Segro, which fell -17%). The death of this sector has been greatly exaggerated but, with record low yields, the key attraction of high rental growth needs to remain resilient in order for these valuation levels to be sustained. We remain highly selective within the sub-sector and back management teams with strong development and leasing track records.
Mergers and acquisitions activity continued, with an all-share merger announcement between Shaftesbury (SHB) and CapCo to create a £3.5bn West End retail landlord. A merger has been expected since CapCo took a 26% stake (from Samuel Tak Lee) in SHB during May 2020, alongside Norges being a major shareholder in both companies. The merger terms are somewhat puzzling, with CapCo set to acquire SHB but the former trades on a steeper net tangible assets (NTA) discount. The merger terms are still being finalised; minorities are pushing for a parity based on the two companies’ respective NTAs and not share prices.
The other M&A deal in the UK made strong financial and strategic sense; LXI and Secure Income Real Estate Investment Trust (REIT) (SIR) agreed to merge on NAV for NAV basis. This creates a liquid and cost-efficient REIT with a £3.9bn portfolio of index-linked income assets and an average lease term of 26 years.
Finally, in Germany, a consortium led by Oaktree and Alexander Otto made a takeover offer for Deutsche Euroshop, the German/CEE shopping centre landlord, at a 44.0% premium to undisturbed share price and a 41.5% discount to DEQ’s reported EPRA NTA. Alexander Otto already owns 20% of DEQ and controls ECE, the external investment adviser of DEQ. The read-across to other European shopping centres may be limited as it brings DEQ’s discount in line with the rest of the sector, despite DEQ’s higher share of fashion retailers in their tenant base.
The full-year results for the Trust were published on 1st June and the Board recommended a final dividend of 9.2p (prior year 9.0p). This brings the full-year dividend to 14.5% with a divided yield of 3.5%.
Discrete rolling annual performance as at 31.10.2022 (%):
not be considered a guide to future performance. All fund performance data is net of all fees