March was another positive month for listed real estate company share prices with the EPRA Europe Index (TR, in GBP) +4.06% in the month. Investors warmed not only to broadly positive news flow from property companies reporting full year results, but also from a more optimistic response from Europe’s political leaders and central bankers culminating in a further strengthening of the fiscal bailout system to €700bn. However, the severity of the structural reforms required across the eurozone are underestimated at one’s peril. Spain remains in a difficult place announcing further austerity cuts of €27bn in the 2012 budget. Further falls in house prices and rising unemployment figures (particular in the 18-34 yrs) points to further quarters in recession. Whilst the Fund has no direct exposure to Spanish property companies, a large number of property companies have pan-European portfolios particularly in the retail space. We monitor all our country exposures very carefully and minimising that particular country exposure is vital. On the other hand, Italy saw returns of 11% and 12% respectively from Beni Stabili and IGD as the cost of Italian sovereign debt tumbled from 7% to 5%. We maintain our long position in Italy.
The Ordinary share class NAV with income increased by 5.1% in March and brings the financial year-end figure to -8.5%. This compares to 4.1% for the benchmark in the month and -8.9% for the year, slight outperformance in both cases. The gearing remains at 9.1% but the property assets are 11.5% of the net assets. The property portfolio rose in value by 2.1% in the six month revaluation at the end of March and thus contributed to the 1% outperformance in the month.
At the country level, alongside Italy, Germany was the other strong performer (+9.5%) as investors became more comfortable with the eurozone’s issues and bought both the most likely beneficiary and the most bombed out parts of our universe. Traditional safe havens such as Belgium and Switzerland underperformed. We however continue to have concerns about over optimism particularly towards the European consumer. The Fund positioning remains focused on high quality companies with strong balance sheets. We continue to expect buying opportunities from the deleveraging cycle for those businesses with firepower. Unibail’s raising of €750m through a 7 year bond at a yield of 3% (105 bps spread) in mid March is illustrative of the attractive cost of capital for those who can access it.
February was another positive month for listed real estate company share prices. The year-end reporting season got into full swing, with most companies reporting positive growth in net asset values, earnings and dividends. There has been little evidence to support sell-side analyst forecasts of negative capital growth for 2012.We remain confident in our own forecasts for low positive capital growth across the sector, albeit showing wide dispersion between sectors and countries.
The Ordinary share class NAV with income increased by 1.76% in February, giving a total of 6.54% for the calendar year to date. This compares to 1.53% for the index in the month and 5.56% for the first two months of the year. The outperformance by the Fund reflects our positioning in high quality companies exposed to those sub-markets which we believe will perform best in a low growth environment. Gearing at 10.6% reflects the 11.8% exposure of net assets to physical property (of which 78% is exposed to London assets).
Consequently, the exposure to equities is broadly ungeared. Our slightly positive view of certain key underlying real estate markets continues to be tempered by expectations of further volatility in both equity and bond markets.
The Eurozone continues to be the main source of volatility. The second ECB three year Long Term Refinancing Operation injected a further €530 billion of liquidity into the financial system albeit part of this was offset by lower take up in shorter refinancing operations earlier in the month. Whether there is a causal link or not, Italian 10-year bond yields have fallen to around 5% for the first time since last summer, putting a spring in the step of Eurozone politicians. The performance of Beni Stabili, Italy’s only listed REIT has been highly correlated and the stock has recovered 46% from its mid-December low point. The Fund has a long position in this company.
However, at the same time a number of peripheral Eurozone countries including Greece and, more worryingly, Spain continue to miss their deficit targets, pointing to the major structural changes that need to take place within Europe over the long term if further crises are to be averted. The Fund continues to have no direct stock holdings in Spanish real estate companies.
Within the direct property portfolio, we continue to progress lease negotiations at our office building in Harlow with an existing tenant.
Pan-European real estate equities rose 3.85% in the month. This is a modest total figure compared with the performance from the intra-month low point on 9 January to the end of January which was +8.6%. The wider European financials sector rose even more, 13.3% from 9 January whilst the broader equity market responded more modestly to this renewed ‘risk-on’ phase with EuroStoxx 600 rising ‘just’ 3.4%. The performance laggards of Q4, 2011 principally the share prices of the Continental financial institutions responded to the consensus view that the long-term refinancing operation programme providing effectively unlimited three-year liquidity by the ECB was a significant positive for the Eurozone banking system. Real estate, as a levered asset class predictably benefitted. Our view is that such liquidity is most welcome but it is only that – liquidity – and not the solution to the problems of bank and sovereign solvency.
The Fund reduced exposure slightly in the month, raising 1.5% of NAV through sales in the last few days. The Fund had relative outperformance in the month with the NAV with Income rising 4.7% exceeding the index which rose 3.8%. The relative overweight positions to the UK (which rose 5.4%), Italy (+7.6%) and Norway (+15.2%) helped, whilst our underweights to Austria (-7.5%) and Switzerland (-0.6%) also aided performance. In the UK, the Central London focused stocks performed well with Great Portland +11.5%, Shaftesbury +8.4% and Derwent London +7.2% whilst the large caps with London exposure, Land Securities +6.1% and British Land +7.1% also performed well.
The sales made reflected the strong performance of a number of stocks particularly our largest position, Unibail. The company announced good results on 1stFebruary but the share price had been driven to €150 per share and the year end NAV was reported at €137.5. The business is very well run, owns excellent assets and the share price performed comfortably ahead of its peer group in 2011. The Fund now has a market neutral position and the stock remains our largest absolute position.
Whilst the accommodative practices of the ECB are most welcome, we continue to see polarisation in physical property markets with a wide disparity of returns across sub-markets. GDP forecasts have begun to improve particularly in the core Continental European countries as well as in the UK and our focus remains on well financed businesses operating in the major centres – both commercial and retail in these countries.
Pan-European real estate equities fell by -3.08% in the month. Whilst clearly not a good figure, it was all looking significantly worse half way through the month. The index sold off daily from the beginning of December until 14th recording -9.3% month to date. This was a new year to date low and an index value last seen in August 2010.
For a levered asset class, the likelihood of further reductions in lending capability amongst eurozone banks is a significant risk. The Fund continues to focus on businesses with limited leverage and where any near term refinancing is manageable. Several of our largest positions have also successfully tapped bond markets and made private placements, thus securing additional lines of credit and this is to be applauded.
Much like November, the latter part of the month saw a partial reversal of the sell-off with gains of 6.8%, in the second half of the month. Of course, the holiday period resulted in lower than average volumes and three ‘up’ days into the year end. The subsequent weakness in January would imply an element of window dressing into the year end.
Individual stock price movements continue to be driven by macro sentiment. The largest Italian listed company, Beni Stabli is a case in point with its share price rising +11.1% in the month, but still down over 40% for the year. The narrowing of the spread in Italian sovereign bonds in late December clearly helped. The company owns a high quality portfolio primarily focused on Milan and Northern Italy with over a third of its income from Telecom Italia. We have been buying on weakness with the shares at less than a third of asset value.
In France, the need to raise equity amongst financial institutions continues to weigh heavily on those property companies with dominant institutional owners such as Klepierre (BNP 50%) and Silic (44% Groupama). In the latter case, Groupama announced that it will back an all share merger with Icade to create France’s largest owner of office property. However, the exchange ratio offers no premium to Silic’s minority shareholders. It merely appears to be a function of Groupama’s precarious financial position.
The Fund continues to have an overweight position in the UK through both equities and physical property. Elsewhere, our largest overweight positions are in Germany, France and the Nordics. The French exposure is dominated by Unibail, which was the top performing country stock down 2.6% in the year, versus -8.4% for the French stocks collectively.
Pan-European real estate equities fell by 5.2% in the month. On the face of it – not a good month. However, this figure reflected a remarkable change in investor sentiment in the last week of the month. From 1- 25 November, real estate equities were down nearly 14%, only to stage a 9% recovery in the last five days of the month. November was the mirror image of October (which saw 3 weeks of ‘risk-on’ with a 13% rally, followed by a correction in the last five days). Markets remain sentiment driven, overshadowed by the next ‘noise’ on the eurozone political landscape. After the mild euphoria in the run up to the summit on 27 October, November saw investors focus on the lengthy timetable that any political solution by the 17 member states would require. Markets danced to a faster beat and the crisis in Italy pushed 2-yr sovereign debt yields to over 7% – an unsustainable level. Whilst Greece is peripheral, Italy is not. As we enter December, there appears to be renewed political momentum and coordination of response between Germany and France – the decision makers. Our strategy remains bottom-up with the focus on positioning the Fund for an enhanced period of economic slowdown across Europe – our best case scenario. All is not doom and gloom, however, equity repricing has resulted in the sector offering earnings yields of 6.75% with dividend yields of 5.5%, all covered and rising. Discounts to current NAV are now in excess of 15%.
Unsurprisingly, the Italian stocks, Beni Stabili and IGD were both hit hard, falling 28% and 26.8% respectively. Such is their volatility they recovered 14% and 10% in the first week of December. In a ‘risk-off’ period, once again the Swiss (-3%) and Belgium (-0.4%) companies outperformed, falling far less than the broader property equity market. Whilst the Fund is underweight both Switzerland and Belgium, it is overweight the UK stocks on grounds of both valuation and currency. The UK stocks outperformed falling -2.2%. The weakest performer of the large caps was Segro which fell 7.6%, mainly on the expectation that a change in strategy would result in a large scale sales programme. Grainger was the top performer (+30%) announcing that it completed its refinancing (£0.9bn). Whilst good news, the increased interest bill will lead to reduced earnings.
In Germany, Deutsche Wohnen completed a 1 for 4 rights issue at €9.1 per share; we took up our rights and remain overweight German residential property through Deutsche Wohnen, GSW and TAG. The Fund was a small net seller over the month. The largest purchase was the rights issue take-up.