Matt Norris, Investment Adviser to the VT Gravis UK Listed Property (PAIF) Fund.
“Location, location, location.” When it comes to buying or renting property, location has always mattered. It plays a big role in its desirability and value – is a home near a good school, is an office easily accessible? Location is more than a buzzword. It is a top consideration in the decision-making process.
But it’s not the only consideration, particularly when it comes to property investing. In modern society, there are other equally important factors and, if you want to secure reliable income for the long term, the sector and quality of assets come into play. It’s not as simple as buying the asset class – you have to choose your investments carefully.
Why sector matters
Two historically lucrative sectors for property investors have become less appealing over the past few years. Changing consumer behaviour has caused issues for traditional retail outlets. Likewise, different working patterns have changed the way we view office buildings. Today, I believe it’s the mega trends driving future property returns: the aging population, digitalisation, urbanisation and generation rent. And the sectors these mega trends touch have evolved significantly.
Take the over 85s, for example. The UK – like many other countries – has an aging population. In fact, the over 85s segment is projected to grow by more than 55% over the next 15 years*. The shifting demographic will increase the demand on primary healthcare and residential care, opening up opportunities for property investors in the likes of GP surgeries, hospitals and nursing homes.
At the other end of the age spectrum, the number of 18-year-olds in the UK is expected to grow by 16% by 2030*, giving a positive outlook for student numbers and the need for both purpose-built student accommodation and apartment buildings for ‘generation rent’.
The digitalisation of the world economy is also bringing with it exciting changes in commercial property. With online shopping already representing more than a quarter of retail sales in the UK and continuing to grow, demand for e-commerce is driving the need for industrial logistics, self-storage and data centres.
Linked to this is urbanisation. While the requirement for office buildings has reduced in recent years, they are still needed. But how tenants use the space and their expectations have changed. Green is the new ‘prime’, with businesses looking to rent or buy buildings with high sustainability credentials – and new regulation insisting that energy efficiency improves. Landlords and property developers that fail to meet the new standards could find themselves left with ‘stranded’ undesirable assets.
Quality not quantity
There are more than 80 listed companies in the UK real estate sector, with a combined market cap of over £90 billion. But if you want liquid, tradable companies and to avoid yesterday’s sectors, the list reduces to around 45. After more rigorous research, this number is reduced further to around 25 in the VT Gravis UK Listed Property (PAIF) Fund.
The Exchange Traded Fund (ETF) black box may be all about “Market Cap, Market Cap, Market Cap”, but just because something is big today, doesn’t mean it’s future is as bright as it has been in the past.
UK Real Estate Investment Trusts (REITs) have been trading at a wide discount to net asset value (NAV) for some time: around -20% vs the 10-year average of -15.9%. While this might seem like a tempting opening for investors, it’s important to remember that some sectors are on a wider discount for a reason.
Some bargains may in fact be value traps, as evidenced by the fact that over the past 10 years, a portfolio of REITs trading at the highest premium to NAV has outperformed those trading at the largest discount. Good quality REITs that own purpose-built next generation assets tend to trade closer to net asset values as the market anticipates far stronger rental growth from assets that are in short supply, but are – and will continue to be – in strong demand.
The good news, however, is that even high-quality next generation real estate looks good value today. What’s more, valuation yields are stabilising.
Securing a growing and reliable income
Income has always been important for investors and today, never more so. The FCA Thematic Review TR24/1 on retirement income was published earlier this year. Within the review, it said advisers have a key role in this market. “They have an opportunity to demonstrate the value of their advice and services to help consumers make decisions about meeting their income needs sustainably in decumulation.”
REITs can be of help here too, but careful selection by an active manager with decades of specialist experience and who understands the value of the income is key. The best quality REITs have successfully increased their dividend per share over many years. Derwent London, the largest central London office-focused REIT, has a track record of doing so for 30 years, for example, while PHP, leading investor in modern primary healthcare premises, has clocked up 26 consecutive years. Positive rent reversion is also helping the likes of SEGRO, Tritax Big Box and Urban Logistics REIT today. The upside potential of this embedded growth for some of these companies is well above 20%.
By carefully selecting REITs, the VT Gravis UK Listed Property (PAIF) Fund provides a reliable quarterly income and has achieved inflation-beating 6.3% annualised growth in dividends since its inception. Not only that, but its 4.8% trailing dividend yield significantly exceeds that of UK REIT ETFs.
A final thought
Two key fundamental advantages of an active fund over an ETF are diversification and cost. For example, an active fund has the ability to participate in new issuance of equity such as placings. Over the past couple of years in particular, this has been a big boon. Since inception in 2019, the VT Gravis UK Listed Property (PAIF) Fund has participated in no fewer than 25 placings, investing c. £15.1 million and, by doing so, made savings of 145bps for investors. This equates to more than 30bp in savings a year i.e. just shy of half of the Fund’s annual management charge (AMC) of 70bp.
In terms of diversification, buyers presume when buying an ETF that they will receive a fully diversified portfolio. However, we have seen UK ETF portfolios with a weighting close to 1/5 of the entire product invested in just one company – namely SEGRO. We at Gravis like SEGRO and believe the company has a terrific portfolio of properties but believe such a high weighting is giving up an investor’s one free lunch: diversification! After a difficult period for the asset class, things are looking up. The interest rate easing cycle has begun, with a number of central banks cutting interest rates. With financing costs declining, takeover activity may intensify. Credit spreads – the difference between the rate at which REITs can borrow and the central bank rate – have shrunk, valuation yields have plateaued, and rents are growing, so values should climb higher as new supply will take some time to come in. This is all good news for REIT investors.
*Source: ONS
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About Matthew Norris
Matthew is responsible for the oversight of the VT Gravis UK Listed Property Fund and the VT Gravis Digital Infrastructure Income Fund.
Matthew has more than two decades investment management experience and has a specialist focus on real estate securities. He served as an Executive Director of Grosvenor Europe where he was responsible for global real estate securities strategies. He joined Grosvenor following roles managing equity funds at Fulcrum Asset Management and Buttonwood Capital Partners. He also provides expert input to research projects run by EPRA, which focus on the importance of emergent real estate sectors.
Matthew graduated with a degree in Economics & Politics from the University of York. He is a CFA charterholder and holds the Investment Management Certificate.
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