John Redwood, Charles Stanley’s chief global strategist, sees opportunities for contrarians in the UK commercial property market.
UK property is popular with many individual and overseas investors, but it has been out of favour with many professionals in the UK property market ever since the Brexit vote.
On the news of the UK decision, valuers sought to mark commercial property down substantially. They anticipated a flight by investors, a reduction in demand for City offices and uncertainty by the corporate sector generally about taking on new space commitments.
In addition, there were some attempts by investors to get out of property funds, which soon led to the imposition of controls on exit from the pooled vehicles affected.
The market surprised investors by its resilience. Buyers quickly emerged, wanting to pick up any commercial properties available at a discount to pre-vote prices. Some large properties were sold to new owners above valuations.
London proved attractive to new tenants, with good demand for space at maintained rents. Foreign investors could take advantage of a lower pound to go shopping for buildings. Long-term UK investors were also willing to add to holdings. Industrial warehouses were especially well-bid.
Most investors need to buy commercial property through some pooled managed vehicle, as they do not have sufficient capital to build a balanced property portfolio where each building may cost millions.
There are two main ways of doing this. Property funds gather capital from numerous investors and construct a portfolio of real estate. The unit holders can sell their holdings at stated dates, but may find at any given time there is a substantial discount or even some restriction on sale.
If too many try to sell at the same time it may mean the manager needs to sell buildings from the portfolio to raise enough cash to pay them out, which can take time and lead to poor prices being achieved. Buyers of property funds need to understand it is a longer-term investment, and to look through periods of price weakness to avoid distress sales.
The alternative is to buy into Real Estate Investment Trusts (Reits). These are quoted property investment companies where you can buy and sell the shares any time the stock market is open.
When people are worried about property, Reit shares may go to a substantial discount to the underlying value of their properties, but you will be able to sell. Reits do not have to sell their portfolio properties when shareholders sell, as shareholders always sell through the market to replacement shareholders, leaving the capital untouched in the company.
It is easiest to chart the performance of Reits as there is an index of the main Reits. In the year to 30 June 2016 this Index return was a negative 10.4 per cent, mainly owing to the late sell-off after the vote. Over the subsequent year to 30 June 2017 there has been a gain of 9.3 per cent.
However, Reits are still a little below where they were at the last peak in 2007. They experienced a very large decline to March 2009 during the financial crash, when commercial property values were badly hit.
Many in the market remain nervous about future tenant demand. They look at the substantial new space being built in London in general and in the City in particular, and worry about the impact that will have on rents. There are also concerns about the impact of internet shopping on the need for retail space.
But it is important to remember just how large the London commercial market already is, and how modest additional space from construction has been in the years since the crash. The IPF survey in 2015 valued total UK commercial property at £871 billion, with £330 billion of that in London. Retail accounted for 41 per cent and offices 31 per cent.
It is possible, therefore, that fears have been overdone. Recent demand for space has been particularly pronounced for technology businesses, which are growing rapidly in the capital.
Reits are currently at substantial discounts to their stated asset values. They have marked down these values modestly over the last year, and are turning cautious over new development commitments. There is still plenty to worry about: any suggestion of rising interest rates does not help these shares, and the market may not be about to fall back in love with them.
Meanwhile many other investors still do like UK property as an asset class. It is delivering decent income from rents with some added opportunity from up and coming areas and from good improvements and changes of use.
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