What is wrong with the property market? The fortunes of the sector are well illustrated by the dismal performance this year of commercial property fund TR Property Investment Trust (LSE: TRY). This £1.4bn real-estate investment trust invests primarily in the shares of property companies, with 62% of assets in Europe and 41% of these in the UK, plus 7% in direct UK properties (the excess 10% represents borrowings.)
Around 65%-70% of the trust’s portfolio has inflation indexation built in, says manager Marcus Phayre-Mudge. The dividend has grown at 8% a year for the last decade. Yet the trust’s shares have fallen 45% this year. They yield 5.2% and stand at a discount to net asset value (NAV) of 9%. Many of its underlying holdings also trade at significant discounts.
TR Property’s discount looks overdone
There is a consensus that there is a price correction going on in the property market, but no agreement on how far or how fast, says Nick Gregory of Waypoint Asset Management, which manages several property funds. “The significant rise in interest rates has caused some debt-backed investors to pull out of purchases. Where yields are very low, such as in the industrial and logistics sector, the impact has been greatest. Investors looking for long, secure income are having to adjust their pricing given that they benchmark to gilt yields.
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“As falls in the CBRE commercial property index show, valuers, who usually lag the market when it comes to downgrades, are keen to catch up this time but there are very few transactions at reduced pricing.” There is something of a phoney war going on: valuers and especially investors are discounting a bear market in property for which there is very little evidence at present.
In the City of London, the planning committee has never been busier, says Chris Hayward, who chairs the Policy and Resources committee, “Tenants will still need the same space, but it will be used differently.” Mondays and Fridays remain quiet, but he sees work patterns moving from current two to three days a week up to three to four.
The City has seen a building boom in recent years and 22 Bishopsgate, a 62-storey office block, was completed in 2020. Its 195,000 square metres provide office space for 12,000 workers. It’s now almost fully let. The question is whether it marks the top of the cycle.
In retail, “occupier demand appears to be holding up well”, says Gregory. “There has been no surge in defaults and there are no signs of significant defaults further away.” But he has concerns that inflation-linked rents on supermarkets have pushed valuations up to unsustainable levels.
High valuations prompt portfolio rebalancing
That concern that is shared by Phayre-Mudge, who has reduced exposure to Supermarket Income Reit (real estate investment trust) and sold out of LXi Reit. Other portfolio changes this year include reducing gearing and shifting to more defensive positions. Segro was sold as it had become expensive, as was Unibail-Rodamco, the European shopping centre business which has struggled since it took on debt to buy Westfield.
“Even if a recession is coming, people will still pay their rent, they will still use self-storage and they will stay in education,” says Phayre-Mudge. He holds Vonovia, Phoenix Spree, Safestore and Unite, as well as retail park owner Ediston.
Two months ago, his view was that “with the banks in good shape, we don’t see a repeat of 2008, nor a liquidity crisis nor serious corporate distress. We are not going back to zero interest rates but to rates of 3% or 4%. Property shares have reflected much of this news.”
Now the bear market in bonds has turned into a crash and the sector has suffered further falls, but bond yields and interest rate expectations probably discount the worst. “Opportunities will present themselves,” says Phayre-Mudge. One of those should be TR Property itself.
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