Neil Birrell
Chief Investment Officer
For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
In favour with us, but out of favour with most others; property companies
Kirsty Riddle manages the property company portfolios across the range of six Diversified funds. It has been a very tough environment for the sector over the last 18 months. Kirsty outlines what has happened and, very importantly, what we believe may be a great long term investment opportunity. We have taken the pain in the property company allocation across the fund range but believe there are gains to be had. Over to Kirsty….
Rising bond yields and higher borrowing costs have been painful for the real estate sector, as property yields have subsequently had to adjust to higher rates. This has resulted in steep valuation declines, particularly in the latter part of last year and the beginning of this year. Signs of stabilisation started to emerge however, and even pockets of growth within some subsectors such as retail and industrial.
Despite this, listed property shares continue to trade at meaningful discounts to underlying values. Recent inflation prints have proved unhelpful to the sector, inflaming concerns that central banks need to continue with further interest rate hikes which will weigh on property valuations again, as we saw from the Bank of England recently. We do at least seem to be much closer to the end of the current hiking cycle rather than the beginning, and each incremental increase becomes less impactful on real estate valuations off a higher base. In addition, we continue to see strong occupational markets with rental growth across all subsectors, boosted by inflation linkage across European commercial property leases, and this helps to mitigate the impact of rising yields on valuations.
US regional banking concerns have also weighed on the sector and fuelled concerns that the availability and cost of finance will become much tighter. Importantly, we do not see parallels in the UK and Europe, where lending to commercial real estate accounts for a far smaller proportion of bank loan books. This is largely because of more stringent regulation but also a more cautious approach to leverage following lessons from the Global Financial Crisis.
We also do not see the same level of stress within the office sector. Whilst offices on both sides of the pond are clearly suffering from the impact of working from home and more flexible working patterns, land constraints and tighter planning regulations here restricts supply and results in a more adaptive market; obsolete “brown” offices can be converted into highly sought after sustainable “green” offices or converted to alternative use such as residential.
Indeed, we are seeing a strong separation in the office market across London and other European cities, despite negativity towards the subsector from poor overall headline figures. Whilst corporates may be reducing their office footprint, they are increasingly requiring super prime, sustainable offices – not only to help achieve their own carbon reduction and sustainability targets, but also to attract staff and encourage workers back into the office (with rents a fraction of staff costs). These types of buildings currently account for a small proportion of the overall office market however; corporates looking for larger floor plates are having to pre-let years in advance to secure the space they need (GPE pre-let space at their Aldermanbury Square development to Clifford Chance 3 years in advance), and those that can find suitable space are willing to pay up for it (CBRE reported their highest quarter on record of deals transacting above £100 per square foot in London).
On the other hand, those older, less sustainable offices are becoming increasingly obsolete and subject to declining occupancy and rents, as well as declining values. This provides a great opportunity for skilled management teams (such as those in the listed sector) that can buy up cheaper obsolete buildings and invest profitably to convert to those “green” assets as demanded by the market.
