With many investors mindful of the fall-out from the EU referendum in 2016 on the UK commercial property fund space as Brexit date approaches, some might be focusing on the wrong issues, according to Rathbones’ Alex Moore. 
Moore, head of collectives research at Rathbones, said there are several interesting trends currently at work in the UK property space but many investors might be distracted by events of 2016, a difficult year for the asset class.
“In 2016, what you found was that a lot of investors who weren’t expecting a leave result targeted property funds because property is very economically sensitive and in times of economic stress net asset values [NAVs] can fall in value," he said.
“There was this perception that leaving the EU was going to be bad economically in the short term. There was a wave of outflows and fund managers couldn’t handle all those redemptions and raise capital quickly enough, so they had to suspend funds.”
Source: Investment Association
He added: “We’re now in situation where it could happen again and this relates to whether or not there is going to be an orderly or disorderly Brexit.”
Beyond Brexit, there is another significant trend that is impacting the commercial property space.
The growth of online retailing has had a profound impact on many of the traditional bricks & mortar retailers, which represent around one-third of commercial property assets. Moore said while the trend has been emerging for a number of years, it has only really started to have an impact on retail property prices more recently.
As such, this has led to the emerging importance of a new asset class within property, those that service the booming online retailers.
“If you’re driving along the motorway and see these enormous sheds, these are assets that have been really in vogue and popular,” he said. “This is a reflection of the prevailing macro environment and a structural trend of people doing more shopping online.”
The growth and disrupting effect of online retailer Amazon.com and its ability to offer same-day or next-day delivery has forced competitors to offer similar services, said Moore.
“There is a lot of appetite for very big multi-storey logistic centres that basically store the goods that you’re trying to buy,” he explained. “But also in big urban areas you’ve a lot of smaller warehouses that are growing in popularity because these are the sites that are going to help with same-day delivery.”
He added: “You have a big warehouse on very easy-to-access motorways like the M1 and when you make your order it goes from that site to a smaller site near your urban area and it gets delivered at home.”
For traditional bricks & mortar retailers, however, the impact has been painful. Footfall to high street locations and shopping centres has fallen in certain towns and costs – such as the minimum wage and business rates – have meant that some of the larger retailers with numerous properties have been unable to maintain lease payments.
“House of Fraser is a very good example and even smaller shops out there that have gone into administration because of this; Toys ‘R’ Us last year and Maplin as well,” said Moore. “This is something which I think investors in property have seen coming for a number of years, but it’s only felt the impact in the last year or two now you’re starting to see more media coverage.”
What this means for property investors, the Rathbones collectives research head said, is that many funds with retail exposure are seeing clients walk away from their shops or negotiate lease terms down.
Indeed, there have been a number of high profile CVAs (company voluntary arrangements) – a form of insolvency – in the retail sector recently and leases have been among the first casualties.
“What this tends to mean they can either get a break from what they pay to the landlord or they may shorten leases, but ultimately this will have an impact on how much yield or rental income you get from a property,” he said.
“This is crucial because if you’re a property investor over the long term, three-quarters of your return comes from income. People are [often] too focused on net asset value, which is important but if your leases and rent income are coming down that will ultimately have an impact on your NAV.”
However, one of the most important discussions that investors need to have at the moment is about which fund structure they use to access the asset class.
“It’s a very interesting time for property and it’s an interesting time not only when you look at it from a top-down market perspective but also how you’re getting exposure,” said Moore.
After the run on property funds in 2016, many open-ended funds are now sitting in cash reserves of between 15-25 per cent, he said, however they could still struggle in the event of a market panic.
Meanwhile, structures such as closed-ended funds would be better placed as investors do not have direct exposure to the underlying assets.
However, here too, investors are cool on the asset class with investment trusts having moved from low single-digit premiums to mid double-digit discounts in recent months, said Moore.
Yet, the discussion over structure in the event of a run on property can sometimes overlook the advantages of each.
“Even though open-ended and closed-ended funds are buying in the same asset pool, they can serve the portfolio in different ways,” he explained. “An open-ended fund will have a large amount of cash but what you’re getting is one of the more direct or purest exposures to commercial property NAV.”
Moore said while property might seem sensitive to what happens in the economy, over a cycle open-ended funds tend to be lowly correlated, which is an obvious diversification benefit.
At the same time investors should be aware that closed-ended strategies are more sensitive to investor sentiment than some investors may be aware.
Performance of sector vs index over 6mths
Source: FE Analytics
“In the investment trust structure recently you’ve seen share prices fall because of negative sentiment at a time when NAV is modestly flat or positive, which shows how in the short term you can find that there will be short-term correlations between equities and investment trusts.”
Yet, given the double-digit discounts many closed-ended property strategies are currently trading at, long-term investors with strong nerves may be rewarded.
“Over the long term these can be a good source of yield but you have to handle the short-term gyrations in share price,” Moore concluded.
“If you’re a long-term investor and seeing commercial property on a discount it’s probably going to be more appealing, but one thing to be mindful of is that if you’re looking at an investment trust you really have to understand what the manager is trying to achieve.”