The case for Pan European property companies

Alex Ross

Premier Miton Pan European Property Share Fund

Alex Ross, fund manager of the Premier Miton Pan European Property Share Fund, makes the case for Pan European property companies, highlighting what he believes to be five key positives for the sector.

 

Real assets offering inflation protection
With inflation looking increasingly embedded, a wider range of investors are increasingly likely to seek real assets. Real estate offers differing levels of inflation protection and this is most transparent in European commercial leases, where rents are typically linked every year to an annual inflation index. In the UK, ‘alternative’ real estate sub-sectors, such as healthcare, typically offer rents linked to RPI, although these come with a cap on the level of inflation that can be applied. But it is not just index-linked rents that provide an inflation hedge. For example, self-storage and urban warehouses have such strong pricing power from highly favourable demand supply dynamics that they have previously been able to deliver rental growth well in excess of inflation.


Compounding income streams with largely fixed or hedged finance costs
The Pan European real estate companies market has widely locked-in low borrowing costs and we therefore expect inflation linked rents to broadly filter through to earnings, whilst the sector also has relatively limited threats from inflationary cost pressures due to the comparatively low operational costs for most landlords. As such, there is good transparency for earnings in the next few years. This potential for attractive compounding income is a key benefit for the sector against certain other real asset segments which may not offer such attractive and tangible income streams in our opinion.


Pan European property yields significantly above bond yields
Property yields across the UK and continental Europe remain materially above current government bond yields even after the recent bond yield increases, and this allows a cushion against potential further bond yield rises. This is in clear contrast to the last property downturn in 2007, where bond yields and borrowing costs went above the property yield. Furthermore, it is important to note the current property yield is not a fixed income, and a rising rate environment is likely to be accompanied by increasing rents in most real estate, thus further cushioning this supportive ‘yield gap’ between bond yields and property yields.


Weak current market sentiment versus attractive fundamentals
Within the real estate sector, German residential has been caught up in the sell-off in perceived bond like investments, with share prices moving to wide discounts to asset values, alongside office and retail real estate companies. We highlight that despite rent restrictions limiting increases on in-place rents, German residential is certainly not a fixed income, with expected further rental income growth from a combination of annual rent table increases (which partly incorporate inflation levels), modernisation-led rent uplifts and open market lettings on rent renewals. This is expected to lag the very high levels of current indexation that most other property sub-sectors can capture, but we expect it to broadly match the current market implied levels of inflation in the medium term. Asset values are further supported by German rental housing being valued materially below replacement costs. With increasing construction cost inflation, desperately needed new supply will be further restricted and thus the long term outlook for open market rents has improved further, and importantly, such structural rental increases will remain affordable with the accompanying wage growth.


Creating sustainable real estate opportunity
The DNA of a number of the many office focused specialist property companies is to create value through regenerating low value secondary offices to high value prime. As such, we believe these leading property management teams are uniquely positioned for the next phase of the property cycle – to capture material valuation uplifts from acquiring and converting inefficient brown offices (at reflective low capital values) in good locations close to key transport hubs, and converting these to increasingly high value in demand ‘green’ offices with strong sustainability credentials and suitable for the increasingly flexible working environment ahead. We are attracted to both the economic and social benefits of such environmental improvements from these companies.

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Risks

The value of investments may fluctuate which will cause fund prices to fall as well as rise and investors may not get back the original amount invested.

Property values can rise and fall sharply depending on the strength of a country’s economy.

Higher inflation can lead to some investments falling in value, particularly those with a fixed level of interest, for example government bonds and corporate bonds.

Forecasts are not reliable indicators of future returns.

IMPORTANT INFORMATION:

For Investment Professionals only. No other persons should rely on any information contained in this insight note.

Whilst every effort has been made to ensure the accuracy of the information contained within this document, we regret that we cannot accept responsibility for any omissions or errors. The information given and opinions expressed are subject to change and should not be interpreted as investment advice. Reference to any particular stock or investment does not constitute a recommendation to buy or sell the stock / investment.

All data is sourced to Premier Miton unless otherwise stated. Persons who do not have professional experience in matters relating to investments should not rely on the content of this document.

For your protection, calls may be monitored and recorded for training and quality assurance purposes.

Financial Promotion is issued by Premier Miton Investors. Premier Portfolio Managers Limited is registered in England no. 01235867. Premier Fund Managers Limited is registered in England no. 02274227.  Both companies are authorised and regulated by the Financial Conduct Authority and are members of the ‘Premier Miton Investors’ marketing group and subsidiaries of Premier Miton Group plc (registered in England no. 06306664). Registered office: Eastgate Court, High Street, Guildford, Surrey GU1 3DE.

006445/250422

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