Hitting the UK real estate hot spot
In turbulent times for global markets, the skilful management of high quality real estate assets continues to offer potential for attractive capital and income returns. With a focus on providing diversified exposure to assets in the right locations in the right UK cities, the long-established Schroder Real Estate Investment Trust could be an attractive option for investors.
2 March 2016
A strong long-term record
Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested. Performance shown to 31/12/2015.
1 Source: Schroders, Datastream, bid to bid price with net income reinvested in GBP.
2 Source: Schroders, NAV to NAV (per share) plus dividends distributed.
3 Source: IPD, IPD Quarterly Version of Balanced Monthly Index Funds (including indirect investments on a like-for-like basis).
Schroder Real Estate Investment Trust Limited was established in 2004 with the objective of providing shareholders with an attractive level of income, together with the potential for income and capital growth, from investing in a diversified portfolio of UK commercial real estate. To date, it has succeeded in achieving this aim through the property cycle. Recent performance has remained robust with total returns of 15.8%, over the twelve months to 31 December 2015 compared to 13.0% from its IPD Benchmark*. The recent strong performance was recently recognised by Investment Week awarding the company ‘Property Investment Company of the Year’ for 2015.**
The Company, which currently has a net asset value of £323.7 million*, has been co –managed since launch by Nick Montgomery and Duncan Owen, who is the Global Head at Schroder Real Estate. On 1 May 2015, it converted to a Real Estate Investment Trust (‘REIT’) in order to benefit from the various tax advantages offered by the UK REIT regime.
The Company’s portfolio currently comprises 54 properties spread principally across the office, retail and industrial sectors. To achieve the objective of sustainable income, the fund managers have an active approach to property management. They have a number of asset management initiatives in the pipeline, which have the potential to materially increase both the income and the net asset value of the portfolio. These will be funded by taking advantage of strong market conditions to sell weaker or smaller properties at premium prices and from current cash reserves of approximately £10 million. This activity should help to increase the defensive qualities of the portfolio in terms of lease length and tenant covenant.
The Schroder Real Estate team anticipates that capital values in the UK real estate markets should rise again in 2016, albeit at a more modest pace than in 2014-2015. With capital values up by 25% in less than three years, it’s unsurprising to find some commentators asking whether we are now at the top of the property cycle. However, while the Schroder Real Estate team can understand this sentiment they do not believe it is necessarily rational.
The immediate trigger for previous downturns has been a recession, which has depressed rents and pushed up real estate yields as investors have withdrawn from the market and liquidity has dropped. In addition, commercial real estate has had a habit of contributing to its own downfall, either through excessive borrowing which inflated prices (e.g. 2005-2007), or because of a boom in development which left an over-supply of space (e.g. 1988-1990) and falls in rents.
Supportive economic picture
The Schroder Real Estate team does not see evidence of these usual suspects.
Looking at the economy, the outlook is positive and the consensus is that UK GDP will grow by 2.25-2.50% through 2016-2017. However, the main reason for their optimism is that the UK is finally seeing a recovery in productivity, which should support a steady increase in real disposable incomes and consumer spending. Furthermore, exporters stand to gain from faster growth in the rest of the EU, which accounts for 45% of total exports.
Similarly, there are few signs of excess borrowing. In general, banks and other lenders have continued to take a disciplined approach to commercial real estate and although total loan originations in 2015 are likely to be around £50 billion, they are still well below the peak of £80-90 billion reached in 2006-2007. Moreover, while the IPD All Property Index initial income yield is low by historical standards at 5%, it is still comfortably above the yield on 10-year gilts at 2% and the consensus is that 10-year gilt yields are unlikely to rise to 3% until at least 2018.
The final reason why the Schroder Real Estate team is sanguine is that new commercial development remains at a low point in most markets; the only grounds for concern being the City of London, where a number of new offices are due to complete in 2018-2019. Even so, these levels of development are well below previous cycles. The lack of new development reflects in part the reluctance of banks to fund speculative schemes and in part the hollowing out of the development industry during the last financial crisis.
The Schroder Real Estate team acknowledges that there are, of course, risks around this outlook. One possibility is that 10-year gilt yields jump more sharply in 2016 than anticipated. A second risk is the EU referendum. If the UK were to leave, then UK real estate could be hit as various investment banks and institutions, as well as some manufacturers, switch to continental European locations.
From this point in the cycle, they anticipate that performance across different parts of the real estate sectors will become far more polarised. They believe that the best market returns will be achieved by real estate assets which are in the right locations in the right cities, which best suits occupiers’ requirements and maximise their productivity. The aim is to ensure that Schroder Real Estate Investment Trust Limited maintains diversified exposure to these areas so that it retains its record of delivering attractive returns for shareholders in the years ahead.
What are the risks?
- Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested
- Companies which invest in a smaller number of assets carry more risk than those spread across a larger number of assets. The Company will invest solely in property located in one country or region. This can carry more risk than investments spread over a number of countries or regions.
- The Company may borrow money to invest in further investments, this is known as gearing. Gearing will increase returns if the value of the assets purchased increase in value by more than the cost of borrowing, or reduce returns if they fail to do so.
Schroders launched its first investment trust in 1924 and their range provides investors with access to a range of ten distinctive investment opportunities including: UK and Japanese equities, Pan-Asian equities and property.
To find out more, please visit www.schroders.co.uk/its
* Source Schroders 31 December 2015
** Source: Investment Week as at November 2015.
*** AREF/IPD All Balanced Property Fund Index. Use of IPD data and indices : © and database right Investment Property Databank Limited and its Licensors 2014. All rights reserved. IPD has no liability to any person for any losses, damages, costs or expenses suffered as a result of any use of or reliance on any of the information which may be attributed to it. Past performance is not a guide to future performance and may not be repeated.
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