Fund Spotlight: tap into potential recovery and pocket 4.7% yield

The past two years have been difficult for property investors. Property is an economically sensitive asset class, so is responsive to changes in interest rates. Accordingly, the value of real estate has fallen markedly across many parts of the market over the past few years.

As a result, property has been out of favour among investors. For listed real estate investment trusts (REITs), this has led to the widening of discounts between the prices that shares trade at and the net asset valuations (NAVs) of portfolios.

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When interest rates are low, property provides investors with an attractive level of income and gives diversification to equities and bonds. However, with high-quality government or corporate debt seeing yields rise in response to rate rises, many investors have turned away from real estate.

But amid negativity in the sector, there is opportunity. The fall in valuations in 2022 across property very much slowed in 2023, which could be an indication that the bottom of the cycle is near. Property is a rate-sensitive and leveraged (high levels of borrowing) asset class. Reflecting weak investor sentiment, the share prices of listed property companies are looking cheap versus historical prices and relative to other sectors.

Just as markets can be quick to discount property, the prospect of interest rate cuts can mean the asset class reprices quickly. The prospect of rerating may be a compelling short-term reason to get into the asset class, although timing the bottom of the cycle exactly is tough – we’ve seen a handful of false dawns already over the past six months.

Moreover, as well as capital appreciation, income is a fundamental long-term attribute of property investing that ought not to be overlooked. Even in times of market stress, the income return of property has historically comprised a stable and significant portion of the total return. In many cases, the rents supporting the yield will naturally inflate over time, or may even be protected by indexation of rents.

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A fund well suited to access the yield on offer from real estate and navigate both listed and direct property is TR Property Trust (LSE:TRY), which has been managed by the hugely experienced Marcus Phayre-Mudge for the past 19 years.

What does the trust invest in?

TR Property takes a hybrid approach to investing in pan-European property, which means the trust invests in listed European property-related securities, but is also permitted an allocation (up to 15%) to physical property. It currently yields 4.7%.

The benefit of the hybrid approach is that the listed property securities component provides daily liquidity in the fund that direct property exposure doesn’t. The closed-ended structure also means that investments don’t need to be sold to fund redemptions – an issue that investors in open-ended funds can run into.

Other things of note are that currencies are hedged back to sterling, meaning investors aren’t taking on European currency risk.

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Gearing, meanwhile, is currently at 10% and is financed at reasonable rates. This level reflects some optimism regarding the trajectory of the market.

The fund is benchmarked against the FTSE EPRA Nareit Developed Europe Capped index, but is able to have some non-European exposure. In the listed portfolio, Phayre-Mudge looks for competent management teams that are overseeing quality assets, and strong balance sheets.

The team are very active stewards of capital and meet and engage on a regular basis with company management. Exposure to bricks and mortar, which currently spans two buildings, makes up roughly 4% of the portfolio following a recent sale, but is often higher than this.

The listed portfolio holds around 33% in UK and 64% in European companies, of which France and Sweden (a combined half of the European allocation) are the largest exposures.

The team use a proprietary mechanism of classifying property sectors, which shows a high allocation to industrials, German residential and UK diversified companies. UK offices is a very marginal (<1%) allocation, whereas European offices, where footfall isn’t so muted by hybrid and remote working arrangements, are more heavily allocated to.

How has the trust performed?

TR Property has a stellar track record. While the trust suffered in 2022 alongside its benchmark and experienced an unusual widening of the discount, over 10 and 15 years, it has returned an annualised 3% and 4% more than its benchmark.

While the trust does trade on a discount (circa 7%), it is not plagued by the deep and persistent discounts of those trusts invested only in direct property. It has traded, on average, at a discount near 6% over the past three years, at times moving to a small premium.

Source: Morningstar - Market Return (GBP). Past performance is not a guide to future performance.

Interestingly, the stress born by the sector has cultivated a good deal of consolidation and mergers, and acquisition activity in recent years. TR Property has navigated these corporate actions successfully.

Attribution data over three years shows how companies that underwent corporate actions, such as VIB Vermoegen AG Registered Shares (XETRA:VIH1), McKay Securities, and Hibernia REIT among others, provided a welcome boost to performance for the trust.

Why do we recommend this trust?

TR Property benefits from Phayre-Mudge and team’s long tenures and abundance of expertise across direct and listed property, as well as access to the wider Columbia Threadneedle resource.

The track record of the trust, from its beginnings at Thames River, and now with Columbia Threadneedle, speak to a time-tested process and consistent ability of the manager to outperform.

The listed portfolio is well diversified across both countries and sectors, while the direct property allocation gives the team a finger on the pulse of the asset class underlying the listed universe.

The closed-ended and hybrid structure provides some assurance that typical liquidity issues that might befall an open-ended direct property fund, shouldn’t trouble investors here.

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Another area of strength is the income-producing quality of the trust. The yield of 4.7% far surpasses that of the benchmark (2.6%). The trust has an impressive record of growing the yield year-on-year and will, on occasion, pay a distribution using revenue reserves (for example, in the immediate wake of Covid-19). This is prudently managed, however, and a very healthy revenue reserve is maintained to deal with potential earnings shortfalls. Dividends have increased for the past 13 consecutive years.

Property exposure can serve as a source of diversification and income in an investor’s portfolio. With REITs having been under a huge amount of pressure, an active and risk-managed approach is a good way to tap into the potential upside for the sector.

TR Property is a unique and well-managed proposition, with a competitive yearly charge of just 0.63%. Accordingly, the trust holds a place on ii’s Super 60 rated list.

The latest factsheet can be viewed here.