TR Property: ‘swift recovery’ coming as interest rates peak

TR Property (LSE:TRY) investment trust manager Marcus Phayre-Mudge sits down with interactive investor’s Sam Benstead to discuss the outlook for the property sector. 

After a difficult couple of years for the trust, linked to rising interest rates, Phayre-Mudge explains why the outlook is now brighter, especially for those taking an active approach to investing. 

He reveals how he is investing, how the pandemic has changed the property market, and why a recovery is around the corner. 

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Sam Benstead, deputy collectives editor, interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Marcus Phayre-Mudge, manager of the TR Property investment trust. Marcus, thank you for coming into the studio.

Marcus Phayre-Mudge, manager of TR Property investment trust: Thank you, Sam.

Sam Benstead: So, can you please tell me a little bit about the investment trust? What are you investing in, and how do you do it?

Marcus Phayre-Mudge: TR Property Investment trust is quite unique. It is the only investment trust specialising in real estate, primarily real estate equities, but it also owns a little bit of physical property. Our real estate equities are all over Europe. So, we're fully pan-European in that respect and our physical property is just in the UK and it's just commercial property. But on a pan-European basis, we do invest through listed companies in both commercial and residential property.

Sam Benstead: And that physical property, so you are owning the buildings outright, what share of the portfolio is that at the moment, and is it typically about that much?

Marcus Phayre-Mudge: Yeah, it's currently 7%, which is a bit lower than normal. We generally have somewhere between 10% and 15%. That might seem like a relatively small percentage, but it's really useful for us because, one, it helps us illustrate to companies that we're investing in that we can make money out of physical property as well by improving and the way we're buying and selling, and it also gives us direct market access. The broker community, the agents, are prepared to talk to us because we're a potential buyer and seller of commercial property.

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Sam Benstead: And in terms of sectors, do you invest across all property sectors? And where are you most concentrated?

Marcus Phayre-Mudge: Well, we actually invest across a very broad range. At the moment, our major exposure is to logistics and multi-let industrial. Offices, you might be surprised to hear, but primarily in continental Europe, [where] we've seen a much greater return to the office, particularly in smaller cities. So, Madrid, Milan, Stockholm, Rothenburg, Berlin, Hamburg, those sort of markets as opposed to London, and we also focus on very high-quality offices primarily. Otherwise, self-storage, student accommodation, healthcare, these are all markets that we're also invested in. Our retail exposure is focused, again, on the Continent.

Sam Benstead: In terms of where a property portfolio fits into someone at home’s investment portfolio. How would you describe it? Is it defensive, is it about growth, is it about income?

Marcus Phayre-Mudge: Yeah, it's a great question. It really is. It should form part of the sort of value income element of their portfolio. And at the end of the day, these businesses are relatively mature, they've owned their assets for a long time. They do development, they do asset management, but a lot of them are there to drive a steady income from their portfolio.

At the same time, of course, what's happened in the last 18 months, of course, the cost of money has gone up so much that's had a very severe impact on their cash flows. But we are focused very much on those businesses that have got the right type of balance sheet. So, I would say that while we're at the value end of the spectrum, within the real estate world, we're always looking for growth. We're always looking for those companies that are focused on markets that we think are going to see rental growth, i.e. tenant demand.

Sam Benstead: The shares are having a difficult run and that is linked to rising interest rates since the end of 2021. What is the impact of interest rates on property, and why are your shares falling?

Marcus Phayre-Mudge: All real estate is leveraged generally, because in a normal cycle the cost of money is less than the cost of the debt. So, it makes sense to leverage that the same way that you will have a mortgage on your house. The problem that has occurred in the last 18 months has been the very rapid change in the cost of money for all the reasons that we know about. So, we have very much been focusing on those companies that are able to manage that cost of debt. Either they've got less in totality or, more importantly, they've been very smart about fixing that debt. [It’s] no different to you or I taking a five-year fixed mortgage, 18 months ago, we'd all be very happy with that. At the same time, for us, it's really about that recurring income. And that's what's really crucial here.

Sam Benstead: And what are the really attractive sectors for income, then? Where are you focusing at the moment?

Marcus Phayre-Mudge: Well, there are two elements to the income story. The first is the quality of that income. Who are your tenants? What's their robust financial position? And the second, of course, is whether you are in a market where rents are going to grow. So, we're kind of focused on a bit of a barbell. In terms of the quality of income, you see that particularly in somewhere like healthcare or student accommodation or residential markets, regulated residential markets in Germany and Sweden, where these portfolios are basically fully led with a waiting list because the rents are sub-market, so that income is very secure.

On the other hand, we're looking for markets where rents are growing, and we see that particularly still in logistics and in multi-let industrial. Self-storage has been a great market for us. And interestingly, even in prime offices there is a shortage of good-quality office space and we're seeing rents beginning to rise in that market as well.

Sam Benstead: There's been a big move in the share price linked to interest rates, as you said. Is it now oversold? Is it a great bargain opportunity to now buy shares in TR property?

Marcus Phayre-Mudge: Yes. I mean, the trust, as you said, is standing on a 7% discount. But when you look underneath at the assets of the real estate investment trusts (REITs) that we're invested in, they are trading on a 30% to 35% discount to their last published asset values.

Now, essentially, that's the market telling you that it doesn't believe those asset values, it thinks those numbers are going to come down. Those asset values are going to fall further, which we also believe is correct. But we think we've very much reached an inflection point.

And when you look over previous cycles, and I've been invested in real estate equities since 2000, so I've been through several of these, and I was a surveyor prior to that, we are definitely at some sort of inflection point because of where the discounts are standing. But more importantly, the fact that if we are not at peak interest rate, we're incredibly close.

So, we see this as a really crucial six months where we could well see a very swift recovery in share prices. Mainly because those discounts are going to close rapidly rather than necessarily that the asset values start to rise, that's the following step. But we've had so much pain in the equity market, we're down 35% since interest rates started to rise that we now think we're into recovery mode.

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Sam Benstead: The portfolio yields about 5.5%. Is it an income trust, and where are you generating that yield from?

Marcus Phayre-Mudge: TR originally stood for Touche Remnant because that was the founding fund management group. And then when we moved to Thames River, of course we all said it stood for Thames River. Now we're part of the Columbia Threadneedle group. We say it stands for total return and real estate is very much a total return animal, but the income is a huge component of that when you look at it over a long period of time.

So, the board very much do want to maintain the dividend and dividend growth. At the same time, there will be short periods, hopefully only short periods where the earnings are less than the dividend and we are probably in one of those points in the cycle now just because we've got a number of companies that have suspended dividends post the pandemic and now they're restructuring their cost of debt, so we expect them to come back and start paying a dividend again, and some of them not until probably 2025. So, if you look at the history of the trust, we have, as I said, on occasion paid an uncovered dividend, but always with an eye to an expectation of growth in the near term.

Sam Benstead: You can get about 5.5% from the investment grade corporate bond market at the moment, similar to your trust. So why should investors buy property over bonds if they're looking for income?

Marcus Phayre-Mudge: Yes, it’s the ultimate question and the answer quite simply is growth. We consider real estate to be an income stream with a capital kicker, and that capital comes through either yield compression where we're not seeing any of that at the moment, or it comes through rental growth. And so for me, the whole thing about the fixed-income market is that it is fixed. So, essentially, I must make sure that I'm investing in companies where we are confident about growth. And what's really interesting, and it started long before the pandemic and, in fact, was a consequence of the global financial crisis, is that we saw far fewer debt providers prepared to take risk. So, in the old days, you went to your developer, you went and borrowed money from the bank, you built the building and you kept your fingers crossed that tenants would turn up.

Post the great financial crisis, the traditional banking community just stopped lending speculatively to real estate and we saw a dramatic reduction in the amount of space provided in all markets.

And, essentially, we're seeing that again. Now there are patches of development, but when you compare, say, Canary Wharf with the West End, we have a vacancy in the West End of just sub 2%. So, you read the horror stories about Canary Wharf and that's quite right, there's a shortage of demand, there has been quite a lot of supply. But in the West End, if you want 10,000 square feet of brand-new Grade A, BREEAM excellent-rated space, I think you've got a choice of two buildings.

So, it's very much an opportunity now where the market is trading at deep discounts to its asset value. But, actually, fundamentals are really quite healthy. The problem, which we're now hopefully coming to the end of is that our balance sheets for many of our companies were in the wrong place 18 months ago, they had too much floating rate debt, they've taken the pain, they've restructured, the shares are trading on big discounts. But actually operationally, I'm really quite optimistic.

Sam Benstead: Marcus, thank you very much for your time.

Marcus Phayre-Mudge: Thank you.

Sam Benstead: And that's all we've got time for today. You can check out more Insider Interviews on our YouTube channel where you can like comment and subscribe. See you next time.