A discounted trust with a 5% yield

TR Property (LSE: TRY) had a wretched time in the year to 31 March, with its net asset value (NAV) and share price dropping by 36%. This has taken the stock back to levels last seen nearly a decade ago. It was also the first time in ten years in which the manager, Marcus Phayre-Mudge, underperformed the fund’s benchmark, albeit only by a small amount.

After recent declines, the stock is trading at a 10% discount to NAV. However, the true discount to underlying value is far greater, because the trust principally invests in listed UK and European property stocks, and these holdings are themselves trading at large discounts to NAV. 

“This is an unusual cycle in which both interest rates and rents are rising,” says David Watson, TR Property’s chairman. “In many of our markets, property fundamentals are sound and we see few signs of over-supply.” Nearly all the fall in value occurred in the first six months of the year, adds Phayre-Mudge. The sector then rallied strongly, rising 15% between October and January, only to give up all those gains in the next nine weeks.

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Around 40% of the £1bn-plus portfolio is invested in UK equities and another 7% in direct properties. “UK property companies are in better health than European ones as they have fallen further but have less debt,” says Phayre-Mudge. Sweden “has the scariest property companies as they have lots of floating-rate debt and the economy isn’t growing”.

Last year “everything just went down”, with only four holdings rising in value. The only consolation was that TRY avoided the worst performers and benefited from four holdings being taken private as well as several mergers. 

Two further holdings, together accounting for nearly 5% of the portfolio, have been taken private since the year-end, including Industrials Reit at a 17% premium to NAV and 40% to the prevailing share price. Phayre-Mudge expects further corporate activity this year, noting announcements by Ediston and Phoenix Spree Deutschland, which are now looking for ways to realise value for their shareholders. 

The tide has turned

Phayre-Mudge believes the tide has now turned for the European real estate investment trust (Reit) sector. Since the end of March, the trust’s NAV has risen by 8.9% against 4.6% for the benchmark index. In response, he has boosted the trust’s exposure, taking gearing from 5% to 15% to NAV.

The odds are in TRY’s favour. The sector has fallen to a near 50% discount to NAV, equal to the low touched in 2008 and close to the lowest levels since 1990. Share prices have been driven lower “by adverse sentiment driven by the expectation of the change in price and availability of debt”, as Phayre-Mudge points out. With inflation now falling and interest-rate expectations dropping with it, that sentiment may be reversing, suggesting a good bounce looks likely.

Still, there are problem areas. One of these is the retail sector. Online sales now account for 30% of the retail market ex-groceries in the UK, so there are empty units in all shopping centres, putting downward pressure on rents in these markets. However, retail parks are doing well, as rents are lower and they can handle returns more efficiently. 

There is also “bifurcation in the office property market, with big cities performing worse than smaller ones”, says Phayre-Mudge. “Lengthier commutes encourage more to work at home.” Best-in-class buildings, that cater for changing requirements in London and Paris are seeing rental growth, but not poorer quality older buildings, for which vacancy rates are much higher.

Despite these headwinds, the sector’s valuation is highly appealing and TRY’s shares should rally a lot further as buyers return. Meanwhile, investors will be paid to wait, with the trust yielding 5.4%.