Don’t write off commercial property

The UK housing market is in the doldrums, but commercial property still has a lot to offer, says Max King.

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High-street retailing will get more difficult before it gets better

The UK housing market is in the doldrums, but commercial property still has a lot to offer.

The residential property market in the UK may have been in the doldrums for the past year, but most of the commercial property market has been in rude health. That was the message from Marcus Phayre-Mudge, manager of TR Property Investment Trust (LSE: TRY), at the company's recent annual general meeting, following a year in which the trust's net asset value returned 14%, and its share price 27%. Admittedly, much of this performance came from the 62% of the trust's assets invested in Europe, but the return from its UK assets has been similar. Since the end of 2015, UK property equities have lagged, with a negative return of 5% compared with more than 50% from Europe, but most of the gap opened up soon after the Brexit vote in mid-2016.

Yet while uncertainty about Brexit "overshadows investment and creates instability, not least in sterling", notes Phayre-Mudge, "there seems no end to the overseas buyers of trophy buildings". Other risks hang over the trust too discord in the EU, rising oil prices (and hence inflationary pressure), and the continued rise in US interest rates (and hence the dollar). However, Phayre-Mudge is "confident in what we own, though careful about what we don't".

Physical retail is struggling

Notably absent from the portfolio is exposure to mainstream UK retailing, other than local and community shopping centres. So it holds property investors such as Shaftesbury and NewRiver, but not the likes of Intu or, until recently, Hammerson. "Retailing will get more difficult before it gets better, with rents needing to rebase and valuations heading downwards There are few transactions, but these are at 10% below asset value."

While physical retail is struggling, online retailing continues to grow "logistics sheds are the new shops". In 15 years, industrial property and retail property have swapped places as the least and most-favoured parts of the market with Segro, formerly Slough Estates, now a sector darling. Student accommodation, self-storage and healthcare have also proved to be growth areas, with secure income streams indexed to inflation.

The office market in central London has been "surprisingly strong". Phayre-Mudge remains cautious, but notes that companies such as Land Securities, Great Portland and Derwent London have reduced their levels of debt, "so there will be no repeat of the 2006 crunch". Meanwhile, the market for offices around the M25 has been buoyant, to the benefit of McKay Securities, which specialises in the development and refurbishment of buildings in less fashionable areas, such as Bracknell, Redhill and Egham.

European markets are in good health

In Europe, rising rents and occupancy rates mean that markets are in good health, while rising wages in Germany have been good for the residential investment companies there. This exposure to Europe will protect the trust in the event of what veteran investor Michael Moule described as "a risk ten-times worse than Brexit; the election of a Marxist-inclined Labour government, which may only be a 20% probability but would result in exchange controls, rent controls, lower sterling and inflation". In that event, Phayre-Mudge would expect to boost the trust's European exposure and focus its UK investment on properties with index-linked income.

At last year's AGM, Phayre-Mudge pointed to a great long-term buying opportunity across the property sector. TR remains the best vehicle for such exposure.

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