Investment trust property picks

The Financial Conduct Authority (FCA) has now proposed measures that could reduce the likelihood of suspensions, but also threaten to kill the appeal of such funds (see box-out). Yet property could prove useful in portfolios once again: the asset class could, in future, give investors both diversification and yield, even if the specific nature of this crisis has seen it struggle on both fronts. It could be especially important if we do see a return to inflation, spurring investors to back real assets.

“Property is very good as an inflation hedge, because people will look for hard assets,” notes David Jane, a multi-asset fund manager for Premier Miton Investors. “If you look at property rents in the very long term, because property is scarce they tend to track nominal GDP with a built-in hedge on inflation. But it’s very cyclical so your entry point is important.”

Property does remain accessible via the investment trust space, but the difficulties facing commercial landlords are far from gone. As such the most vulnerable trusts are trading on huge discounts to the net asset value (NAV) of their portfolios, with more reliable specialist plays looking pricey. But paying up for security may well prove worthwhile, with some speculative picks emerging for especially brave investors.

Reassuringly expensive?

While real estate investment trusts (Reits) and property trusts with broad, diversified exposure weigh up existential questions around the future of both retailers and commercial offices, specialist names have remained resilient. These fall into three main categories: logistics names, healthcare Reits and social housing vehicles.

As the table shows, trusts in this space are holding up well in terms of their fundamental operations, with rental collection looking strong. Many also continue to trade on attractive dividend yields.

Importantly, many of these also look set to benefit from continued structural growth trends, some of which appear to have accelerated amid the Covid-19 outbreak. Logistics names such as Warehouse Reit (WHR), Tritax Big Box Reit (BBOX) and Urban Logistics Reit (SHED) could benefit from the shift to e-commerce, for example.

Other structural trends are at work, elsewhere. Civitas Social Housing (CSH) and Triple Point Social Housing Reit (SOHO), which provide a government-backed, inflation-linked income, have fared well in terms of rent collection and look unlikely to falter in future. Conor Finn, an analyst for Liberum, notes: “The chance that the spending is cut is very slim, especially as these are [dealing with] vulnerable people.”

Separately, Target Healthcare Reit (THRL) and Impact Healthcare Reit (IHR), which focus on the care home sector, both look sturdy after this year’s sell-off initially knocked their shares off course.

A key question with all of these names revolves around price. Most have tended to trade on premiums – but the structural trends driving the performance of these trusts, combined with the scarcity both of an attractive income and a reliable form of diversification, could persuade some that the price is worth paying. The healthcare trusts, for example, could see their shares slip if investors fear a coronavirus second wave, but Mr Finn questions what could unsettle them in the longer term.

“In one regard you could say they look very expensive, but what derails that? You have pretty safe rental growth, no problem on balance sheets, certainty of income and the likelihood of decent rental growth as well,” he says.

As such, it may be prudent to simply seek good entry points and avoid cases where prices look especially frothy. Supermarket Income Reit (SUPR) recently traded at a premium of nearly 15 per cent, which could look off-puttingly high, although other names look cheaper. Tritax Eurobox (EBOX), a logistics play that holds up well in terms of rent collection, recently traded on a discount of nearly 9 per cent.

For investors focused on income, diversification or inflation hedges, specialist property names do look less expensive than infrastructure investment trusts. The latter serve as reliable sources of income and have been broadly unscathed by this year’s problems, but many trade on large premiums.

Risky business

The outlook understandably grows much darker for trusts with a focus on the wider commercial property sector, and much of this appears to be in the price. As the chart shows, some diversified UK commercial property trust shares have traded on huge discounts to NAV.

Even at such prices, any buy would be highly speculative given the uncertainty around both the future of the retail sector and the demand for offices during and after the Covid-19 pandemic. The health of a trust's income stream is especially important. Thomas McMahon, senior analyst at Kepler Partners, notes that wide discounts could therefore prove "persistent" until there is greater certainty around rent collection. 

"There’s still a lag [on the effects of the lockdown on businesses] so rent collection for this quarter could be worse than last quarter. Certain tenants could pay last time but are running on fumes now," he adds.

But it is worth asking whether too much pain is priced in, and some speculative opportunities may present themselves.

Daniel Lockyer, a fund manager for Hawksmoor, has been looking at some of the most beaten-up names. He, among others, has turned his attention to BMO Commercial Property Trust (BCPT).

“That has traded on a 50 per cent discount, implying the NAV will fall by 50 per cent or dividends will get cut by 50 per cent,” he says. “You look through the portfolio and ask if that’s realistic. Has the market put a correct valuation on that pool of assets?”

The trust certainly comes with its problems. It had more than 40 per cent of its assets in offices at the end of the first quarter, with around a fifth of assets in the retail sector. The trust’s board suspended dividend payments in mid-April, stating an intention to reintroduce payments when conditions improved.

But a case remains that the trust is still attractive on current valuations. Winterflood analysts recommended the trust in mid-July, then at a discount of 53 per cent, on the basis that even if dividends were resumed at half their pre-crisis level, this would equate to a yield of around 5 per cent at the time. The trust's board has since done exactly that.

Ediston  Property Investment Company (EPIC) has also traded on a hefty discount, but the portfolio does, potentially, retain some thematic appeal: its exposure to retail parks could ultimately pay off if consumers favour these over a struggling high street in the longer term. More recently the trust has been more successful in rent collection than some others: as of 5 August 80.5 per cent of the rent due at the start of that month had been collected. But this is certainly a speculative play.

Generalist names with an idiosyncratic approach might prove more resilient in the future. Mr Lockyer has been a big backer of Regional Reit (RGL). While it has struggled this year, the trust could be a more resilient play on offices spaces. As its name suggests it focuses on the regions rather than London, which could be particularly exposed as businesses find themselves tempted to do away with expensive rental agreements. Mr Lockyer believes that the dividend yield, which recently came to around 10 per cent, could draw investors back in.