Pan European property shares had their strongest monthly return so far this year rising +7.9% (in euros) and 4.7% (in sterling). The broader equity market (Stoxx index in TR) saw its best monthly performance since July 2009 at +8.1%. Stocks rallied strongly in the second half of the month after the European Central Bank (ECB) hinted it could expand its stimulus at their next meeting on 3rd December. The euro weakened sharply resulting in the poorer performance of the sector in sterling terms.
Due to the frail economic recovery in Europe but also mounting concerns over the Chinese slowdown, market expectations for rate lift-offs keep getting postponed. In the UK whilst the first rate hike was expected in 7 months time back in August, by October this has moved out to 12 months to Q4 2016. In the eurozone this figure is now 38 months away. In Sweden the Riksbank recently pushed back the first hike guidance by 6 months to Q1 2017 citing “substantial uncertainty linked to the global economy”.
The ultra-low or negative corporate and sovereign bond yield environment for an extended period continues to exert an unprecedented hunt for yield. Evidently this has been positive for property shares which have outperformed the broader European equity market by 11.4% year to date.
The Trust’s NAV rose 4.46% underperforming the benchmark by 21bps in the month. This was primarily due to the relative underperformance of the UK (+4.4%), our largest country overweight versus strong returns in local currency from the largest eurozone countries France (+7.9%), Germany (+5.8%) and the Netherlands (+10.2%). The most leveraged companies in the European property sector are to be found in Sweden. The Riksbank’s dovish commentary, pushing back the commencement of a rate rising cycle, saw share prices respond accordingly rising +10.1%. Residential and Stockholm focused businesses continue to be the strongest performers but the standout performance this month came from Pandox, the recently listed hotel owner /operator which rose 14.7% in the month and is up 32% from its June IPO.
The portfolio continues to have gearing of close to 15% but I remind investors that our physical portfolio is now 9% of assets and that element of the portfolio has no separate debt attached to it. We remain focused on markets and stocks where we see rental growth or are confident that tenant demand will lead to rents appreciating in the near term.
The interim results will be published on 25th November together with the announcement of the Interim dividend. The share price has underperformed the recent strength in the underlying portfolio and at the end of October should at close to 7% discount to the net asset value (including income).
All fund returns are quoted in sterling using net performance.
Following the dramatic sell off in equity markets in late August, September was expected to be choppy as investors across the globe awaited the Federal Reserve’s decision on whether to commence a rate rising cycle in the US. Citing the slowdown in China and emerging market volatility as part of the rationale for holding off raising rates, this seemed to spook rather than calm markets resulting in more volatility. Once again, higher yielding companies with secure domestic Developed Market earnings streams proved resilient. The fund’s benchmark, FTSE EPRA/NAREIT Developed Europe Net TR Index (in sterling) rose a satisfactory +1.4% in the month although the volatility meant that it bounced around in a 5% trading range all month. An ongoing feature of returns from the sector has been the outperformance of broader European equities (which have themselves outperformed emerging markets). The EuroStoxx 600 (Net Total Return in euros) fell -4.1% whilst the FTSE All Share Index also fell -2.9% in the month.
Within the sector the most significant corporate news was the announcement of an agreed all paper offer for LEG, Germany’s 3rd largest listed residential landlord by Deutsche Wohnen (the 2nd largest). The deal looks good for LEG shareholders but less so for Deutsche Wohnen and the communication of the deal rationale from its management has been stunningly poor. Whilst the LEG stock rose 10.4% in the month it has subsequently fallen in early October suggesting that there is a risk that not enough Deutsche Wohnen shareholders will vote in favour of the deal. ADO Properties, which had performed poorly since its IPO two months ago rose over 11% post the LEG/ Deutsche Wohnen news as investors expect medium term consolidation to continue in the sector regardless of whether this deal goes through. Elsewhere in Europe residential stocks performed well particularly in Sweden with both Balder (+7%) and Wallenstam (+6.7%) significantly outperforming the rest of their Swedish competitors with the Swedish companies managing just +1.6% (in Swedish krona).
In the UK, Quintain which is being taken private in an agreed cash bid from Lonestar at 131p found itself facing dissent from a 13% activist shareholder and subsequently increased the offer to 141p to the benefit of all holders, ourselves included.
Switzerland, a traditional safe have in turbulent times proved to be anything but safe with the two largest names PSP Swiss and Swiss Prime Site down – 4.3% and -6.1% respectively as investors continue to worry that the economy is moribund and rental values in both Geneva and Zurich continue to drift downwards.
Spain was a stock picking market this month with Merlin up + 3% as investors enjoyed the greater liquidity and size following the 2 for 3 capital raise to fund the Testa acquisition. Meanwhile both Hispania (-7.9%) and Lar Espana (-6.0%) suffered.
The fund’s property assets are externally revalued twice a year and the September interim valuation saw a like for like increase of £6.5m (7.6% increase) to £91.775m. The physical portfolio is now 9% of net assets. This revaluation helped the net asset value rise 2.34% in the month resulting in 94 bps of relative outperformance in September.
Given the dramatic events in global stock markets during the second half of August it is pleasing to report that our benchmark fell just – 0.6% over the month. The benchmark is sterling denominated and with over 50% of our exposure in non-sterling assets, the strengthening of the euro late in the month helped performance. In euro terms the benchmark fell -3.4%. As a reminder, the fund’s currency exposure is always aligned with the benchmark exposure regardless of the underlying stock positioning and this ensures that relative performance is not impacted by currency movements. Whether viewed in sterling or euros, real estate equities were remarkably resilient when compared with broader European equities with the FTSE100 down -6.7% and EuroStoxx600 down -8.2%. Why? We think the sector continues to offer domestic focused income with many markets exhibiting sound fundamentals for rental growth coupled with sustainable earnings aided by lower debt costs. Short term rates in the eurozone are not rising and quantitative easing (QE) may get extended. In the UK where rental growth is now apparent across most office and industrial sector nationwide (but with retail the structural weakling) rates may rise but it is going to be modest.
Across Europe, Germany and Austria were the strongest performers, +1.9% and +2.7% with performance dominated by the residential stocks and in particular Deutsche Wohnen (+4.1%) and Deutsche Annington (+2.8%). In the case of the latter it is partly technical buying in anticipation of Deutsche Annington (now renamed Vonovia) entering the DAX in mid-September. We also feel that investors appreciate the resilience of the income stream from these large residential landlords who also continue to drive rental growth of 2- 2.5% per annum. In the UK, the top performers were the healthcare companies such as Primary Health Property (+0.9%) and higher yielding, quarterly dividend payers such as Tritax (+0.5%). Amongst the larger names Great Portland (-0.5%) and Derwent London (- 0.7%) the Central London specialists performed well following upbeat H1 reports.
With the H1 reporting season now complete (for those with Dec year ends), the broad message was both a mixture of further yield compression (particularly on the Continent) and rental growth (focused in the UK but not in the larger retail names). Businesses such as TLG (diversified German assets) which benefited from both yield compression and enhanced earnings (from lower debt costs) were well rewarded (+3.7% in the month).
The fund’s NAV fell -0.48% narrowly outperforming the benchmark, which was pleasing given that we remain positive (at the fundamental level) and therefore the Trust had some limited gearing (around 7% when adjusted for the direct property exposure) throughout this turbulent time.
European shares responded strongly to the deferral of a decision on the future of Greece within the single currency and real estate shares were no exception – particularly given that they are one of the best ways to achieve domestic European exposure. Following the -5.8% pullback in the previous month, the 30th June proved to be the lowpoint and the benchmark rose 6.8% in July and has added a further 2% so far in August (to 7th). The recovery has resulted in the sector almost returning to where it started the financial year (March 31st). Whilst market sentiment has gyrated with a Q1 intra-quarterly movement of 12% we have also seen a large number of corporate actions as well as new highs in the underlying commercial property investment markets. In other words, there is plenty of investor interest and positive data points in the underlying asset class – property is a popular asset class.
Whilst June saw a rash of capital raisings, July was quieter but not silent. Merlin, the Spanish investment vehicle announced the phased acquisition of Testa for EUR 1.8bn and will complete a 2 for 3 discounted rights issue in August, increasing its market cap by 60%. Citycon completed its EUR 600m rights issue to buy Sektor Gruppen, a Norwegian shopping centre owner and manager. This deal looks expensive but that is masked by the cheap debt available to acquire it. The fund participated in the IPO of ADO Properties a small residential business focused solely on Berlin, our favoured German market.
At the country level returns were remarkably consistent with returns between 6 and 8%, the exceptions were Greece (closed) and Norway (-2%). The latter is dominated by two stocks Norwegian Properties and Entra which remains 50% government owned but we expect that position to be placed in Q4 leading to a stock overhang ahead of the news.
The surprise event of the month was the announcement that LoneStar was making an agreed offer for Quintain at 131p. Whilst this was 22% premium to the prior share price, it is only 6% ahead of the NAV. The share price is currently 133p reflecting the market’s belief that other bids may now materialise. Given that the business is a development play on Wembley residential a cash bid reflects the amount of capital seeking exposure to the sector.
The fund’s NAV rose +7.23% leading to 46 bps of relative outperformance in the month. However, the share price did not keep up with the rally rising 3.1% in the month.
Real estate equity markets across Europe were weak in June with the benchmark falling -5.8%, its single weakest month since August 2013. No coincidence that the primary driver of the market sell off back in that summer was an earlier Greek crisis. However the blame for the market weakness cannot be laid entirely at Athens’ door. The beginning of the month saw the German 10 yr Bund yield rise from 0.5% to almost 1% in a matter of days. This was a continuation of the theme of rising yields (albeit from a very low base) which has been evident since late April as investors sense that deflation is unlikely given the weakness of the Euro and the drop in oil prices helping household budgets and hence consumer confidence. German residential businesses have enjoyed a high correlation with their domestic bond market and this drove German property share prices upwards (+35%) between October 2014 and March 2015. However this correlation resulted in a strong correction through May and June which coincided with Deutsche Annington announcing both a major portfolio acquisition and a capital raise of €2.2bn (in effect a thinly veiled degearing exercise). The stock fell 12.2% in the month and is down 22.8% since the end of February.
Amidst a tempestuous month for property shares, the sector had its highest number of significant corporate actions in any one month period. There were additional capital raisings from New River, Intervest, Wereldhave, Hamborner, Aedifica, LEG and Citycon as well the IPO of Pandox in Sweden and the announcement of a cash offer for Deutsche Office from Alstria. In Sweden, Pandox saw 50% of the B shares listed providing a partial exit for the private family office who delisted the company in 2004. The A shares (and control) remains with them. The fund participated in the IPO (at SEK 106 per share). The effective merger of Deutsche Office and Alstria will create the largest listed office business in Germany but also result in an increased exposure to Frankfurt (the weakest market amongst the big 6 cities).
The UK property companies outperformed their Continental European counterparts in the month as the Greek situation continues to shine a light on the complexities within the Eurozone monetary union. The fund remains overweight the UK versus Continental Europe.
Pan European property shares have now corrected -8.9% since 31st March (the fund’s year end). However, market fundamentals (particularly the lack of new supply of office, industrial and logistics) in many of our preferred submarkets remain robust and we see this correction as a potential buying opportunity – subject to some form of agreement between the European political elite and the people of Greece.
The fund’s relative performance in June was a modest +12bps and the share price went ex the final dividend of 4.75p on 25th June, payable on 4th August. The AGM will be held on 21st July at the RAC, Pall Mall at 12 noon.