UK commercial property stocks look unreasonably cheap, says Max King.
The malaise affecting domestically orientated UK stocks has hit the property sector hard. While the All Share index returned 1% over one year to the end of July and 27% over three, the FTSE Real Estate sector’s returns were –10.6% and 4.5% respectively. Some of this reflects the well-known problems of the retail sector; historic overexpansion, excessive rents, business rates, online competition, and the use of creditor voluntary arrangements (CVAs) by distressed retailers to cut their rental costs and break contracts.
However, says Marcus Phayre-Mudge, manager of TR Property Investment Trust (LSE: TRY), share prices have recently been hit “by an additional level of Brexit risk”, especially as “the market has finally woken up to the real possibility of no-deal”.
It’s not as bad as it looks
Yet, notes Phayre-Mudge, “there have been no areas of oversupply for commercial property. Investment volumes in the City are at ten-year highs, with the occupational market, especially the technology and media sectors, happy to pay up for quality office space”. London office rents overall are falling, but this could be temporary as investment decisions are postponed. “Meanwhile, we are utterly confident of the industrial, logistics, healthcare, student accommodation and self-storage sectors.”
TR’s portfolio has returned 3% over one year and 28% over three. Much of this is due to 62% of the fund being invested in Europe and only 38% in the UK (of which 7% is in directly held property). European stocks have returned 60% in sterling in the last three years, helped by steady growth and low interest rates. Employment growth is pushing up office rentals in all major European cities by “high single-digit percentages”, while only 10% of retail sales in Europe are online compared with 20% in the UK.
Retail rents are also lower, so property values have held up much better. The German housing market has been hit by a rent freeze proposed by the Berlin state government, but “there is very little contagion to the rest of Germany”. Phayre-Mudge also thinks the proposal may be overruled as unconstitutional and that it is discounted in any case in the share prices of his favoured stocks, LEG Immobilien (Xetra: LEG) and Vonovia (Xetra: VNA).
Meanwhile, low rates in both the UK and Europe have “been a positive factor overall”. He remains confident on the outlook; in the UK, “the market has detached itself from a rational valuation and it looks hard for share prices… to drop further, even if the physical market gets worse”.
Shares in the trust trade just above net asset value (NAV – the value of the underlying portfolio), yield more than 3%, and look an excellent long-term core holding, with a built-in hedge against lower sterling, both from its European investments and from the benefit to UK firms – especially in London – from a weaker currency.
UK stocks for the bold
More adventurous investors may prefer to cherry-pick some of the underlying UK stocks, all of which are long-term favourites of Phayre-Mudge. Land Securities (LSE: LAND), with 35% exposure to retail, trades at a 42% discount to NAV and yields nearly 6%, yet has debt at only 20% of portfolio value.
The high-quality Central London office property firms Great Portland Estates (LSE: GPOR) and Derwent London (LSE: DLN) both trade on discounts to NAV of 23%, though their assets haven’t fallen in value. Shaftesbury (LSE: SHB), which owns retail and leisure “villages” in central London, has dropped to a discount of 25%, although it is a prime beneficiary of the tourism encouraged by lower sterling.
This week, troubled enterprise software provider Cloudera reached a deal with billionaire investor Carl Icahn to put two of his representatives on its board. Icahn announced that he had acquired a 12.6% stake in the group at the end of last month. However, as The Wall Street Journal points out, despite this early victory, the activist has his work cut out for him. In June, Cloudera’s share price slid “after a disastrous quarterly report”.
The company warned of increasing competition from the likes of Amazon and Google, and said that it “expects to burn cash for the current fiscal year”. Meanwhile, its chief executive Tom Reilly unexpectedly said he was stepping down. “Icahn may need a long while to make rain from this cloud.”
Short positions… Woodford’s kennel club
• The latest “Spot the Dog” report is out from Bestinvest. Every six months the online broker looks at funds that have been consistently poor investments – to end up in the doghouse, a fund must have failed to beat its benchmark for three years in a row, and by more than 5% over the period as a whole. This time, 59 funds, with a total of £32.6bn of investors’ assets under management, made the list. Investors may not be surprised to learn that the worst-performing fund of the past three years turns out to have been Neil Woodford’s Equity Income Fund, which is currently “gated” (ie, investors can’t put money in, or more importantly, remove it).
The fund missed its benchmark by 38% in the three years to the end of June. Other funds with links to Woodford that make the list include St James’s Place UK High Income fund (which Woodford managed until he was fired by St James’s in June), and Invesco High Income, which Woodford ran until 2013.
• Investors in fund group Vanguard’s largest sustainable exchange-traded fund (ETF) – the Vanguard US ESG Stock ETF – ended up owning shares in gunmaker Sturm Ruger & Co for just over a month, says Bloomberg. The stock was mistakenly included during a June rebalancing of the underlying FTSE Russell US All Cap Choice index, which is meant to screen out companies involved in “vice” industries, such as alcohol, gambling, tobacco and weapons manufacturing. Vanguard apologised to shareholders and the mistake has been corrected.