Jason Baggaley, Fund Manager at Standard Life Investments Property Income Trust Limited, explores the staying power of commercial property and why an active approach is the best way to negotiate external challenges.
- Commercial property is an asset class that has demonstrated strength and resilience in recent years.
- The cycle is mature, presenting different challenges and necessitating an active approach.
- Careful management of assets and meeting tenants’ needs will be vitally important.
Aside from some minor wobbles, commercial property has seen a lengthy period of capital growth in recent years. As with bond and equity markets, which have also seen a strong run, a more nuanced approach is needed as we move to a late-cycle phase. Today, yields are low and price rises have slowed. Nevertheless, there is considerable disparity in underlying markets, and this is where active managers can take advantage.
Real estate is heavily impacted by the turmoil associated with Brexit, as it has a strong correlation with the strength of the underlying economy. There has also been a lot of attention on the impact of changes in shopping habits but this is a far more complex and diverse asset class that has become an integral part of many investors’ portfolios.
While the Brexit story is constantly evolving, the retail story is more structural. Both are likely to have long-term implications. Retail has been the serial underperformer for the last few years. Shopping centres and retail warehouses have been worst-affected, along with secondary high streets. In contrast, industrial property has been the darling of the market, benefitting from the consumer shift towards internet shopping and home delivery. Prices have risen, demand has been high and it has shown real rental growth. Standard Life Investments Property Income Trust (SLIPIT) has more than half of its assets in the industrial/logistics sector and this has been a strategic overweight position for some time.
Forecasters expect industrial to continue to lead the performance tables, with retail propping up the bottom, over the next few years. Such a collective view impacts on market pricing. While industrial is great to own, it is now expensive to buy, with prospective purchasers generally having to price in future growth.
Retail is harder to own but it might provide better buying opportunities. Investors will need to apply strict criteria to invest in retail assets to ensure they continue to provide a reliable income stream and remain attractive for the tenant. Buying in the retail sector will have to be bottom up, asset by asset. Having reduced retail exposure in SLIPIT to circa 9% over the past five years, we now have an open mind to making selective purchases again.
So far, we have concentrated on the best and worst-performing sectors but there is a third area: Offices. At a sector level, offices have held the middle ground in terms of market performance. Central London offices dominate the headlines and are considered most exposed to Brexit risks, but overseas buyers have so far helped hold up prices. SLIPIT has limited exposure to central London offices, having preferred to focus on the South East/Thames Valley area. Here, we have been realising some profits and reducing risk by selling assets where we see tenant demand weakening or significant capital investment requirements.
There are no immediate difficulties for the sector, but how offices are used is going through as much change as retail. The way we live and work is changing – commuting is not popular with millennials and amenities are important if companies want to attract and retain talent. Workplaces need to have a “buzz” but also practical elements such as good quality showers, a bike rack, a decent coffee machine in reception and good wi-fi.
Where does this leave us as fund managers? There are no easy solutions. Commercial property has been strong for 10 years and yields are low today by historic standards. With a slowing economy, expectations for rental growth are being reduced. Unusually for this stage in the cycle, there is a limited supply of new space. Previously the property industry has over-developed at later points in the cycle, leading to a glut of accommodation, but that seems muted this time. We expect interest rates to remain low for a while, and the attractive yield from real estate is likely to continue to attract investors.
Real opportunities remain for those with the resources to look asset by asset. To our mind, the most important aspect today is asset management – visiting tenants and ensuring their needs are properly met. This cannot be outsourced. At Aberdeen Standard Investments, we have a capable team of asset managers and like to take an active approach. This is reflected in renewals and longevity of tenant relationships. In a difficult environment, there is great value in retaining tenants.
It should be said that this market is easier for us to navigate owing to the closed-end nature of SLIPIT. As an investment trust, every decision is based on what we believe to be in the best interests of shareholders and subject to scrutiny by the board of directors. Property does not need to be sold to meet redemptions and we can buy at a time when there are outflows from the sector, which can provide attractive opportunities. Our hand is not forced, so we are always able to shape the portfolio according to market conditions as we see them.
- Aberdeen Standard Investments is a brand of the investment businesses of Aberdeen Asset Management and Standard Life Investments. Risk factors you should consider prior to investing:
- The value of investments and the income from them can fall and investors may get back less than the amount invested. Past performance is not a guide to future results. Investment in the Company may not be appropriate for investors who plan to withdraw their money within five years.
- The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
- The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares. Movements in exchange rates will impact on both the level of income received and the capital value of your investment. There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
- As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen. The Company invests in emerging markets which tend to be more volatile than mature markets and the value of your investment could move sharply up or down. Specialist funds which invest in small markets or sectors of industry are likely to be more volatile than more diversified trusts.
- Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.
Other important information:
Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1XL. Registered in Scotland No. 108419. An investment trust should be considered only as part of a balanced portfolio. Under no circumstances should this information be considered as an offer or solicitation to deal in investments.
Find out more at: www.slipit.co.uk
Standard Life Aberdeen plc is one of the world’s largest investment companies, created in 2017 from the merger of Standard Life plc and Aberdeen Asset Management PLC. Operating under the brand Aberdeen Standard Investments, the investment arm manages £525.7bn, €587.6bn, $669.1bn* of assets, making it the largest active manager in the UK and one of the largest in Europe. It has a significant global presence and the scale and expertise to help clients meet their investment goals.
As a leading global asset manager, Aberdeen Standard Investments is dedicated to creating long-term value for our clients. The investment needs of our clients are at the heart of what we do. We offer a comprehensive range of investment solutions, as well as the very highest level of service and support.
*As at 30 June 2019