Unlocking Opportunities In UK Property Markets

The Brexit vote just over a year ago created a significant amount of volatility in property markets. Concerns over prolonged uncertainty in the UK were offset by the sharp currency devaluation that followed and in aggregate UK property has actually performed remarkably well over the past twelve months. There has however been a notable shift of foreign investment from the UK and into European property funds as investors anticipate an increased demand for office space if financial services companies shift operations out of the UK. Now that the clock is ticking following the triggering of article 50, and with the UK Governments stability in question after the recent general election, headwinds to future returns would seem to have increased. These concerns may be most acute in the London markets and notably the Office sector. With potential for a significant change in the landscape of the financial sector the longer the uncertainty persists and with valuations at elevated levels it would seem reasonable to conclude that future growth is going to be more challenging in these areas.

Within the Thomas Miller Investment Diversified Assets Fund we have an approximate allocation of 20% to property markets. Whilst we are not overly bullish on UK commercial property markets in aggregate we do believe that by being more targeted in our approach and accessing specific niches within markets we can drive positive performance. Areas that we favour tend to be where we see a strong fundamental support and trends that are likely to persist. Areas such as social housing and healthcare property have less sensitivity to the broader economy  and are supported by ageing demographics of the UK. Demand on the occupier side for health care is ultimately driven by the domestic population which will continue to need the services offered by the operators regardless of economic growth. The Logistics sector is supported by the disruption of the ongoing move to online retail. The sector will not be immune to uncertainty around the trade impacts of Brexit but supply remains weak. Further ahead, technological change in the logistics sector will continue to influence real estate preferences. As a consequence our focus is on these specific sub-sectors.

In terms of accessing property markets we have a preference for utilising investment companies as we feel they have a structural advantage over open-ended funds which will lead to superior long-term returns. As was evidenced following the Brexit vote last year, whilst the open-ended funds claim to offer daily liquidity due to the illiquid nature of the underlying investment they are not always able provide this. This also confers a competitive disadvantage, namely that they have to carry a large proportion of cash in order to satisfy redemptions. In contrast REITs (Real Estate Investment Trusts) offer geared exposure (on average 125% of NAV) to property  markets, thus making them a more efficient means of accessing the sector from an asset allocation perspective. For open-ended funds cash levels are currently at particularly high levels.(in some cases above 30%). Although the current mood on this subject seems fairly relaxed this issue was noted by the Bank of England in its twice yearly financial stability report. There is also an FCA discussion paper on the future of open ended funds therefore one wonders whether these cash levels foretell upcoming imposed structural changes. We await the publication of the FCA report with interest.

 
Whilst we favour these more specialist areas and accessing these through the REIT structure a word of caution is necessary. Over the course of 2017 a significant amount of new capital has been raised in the investment trust sector, notably within infrastructure assets, but more recently we have seen a number of new entrants to the REIT sector. This in and of itself is not a bad thing, and there are indeed opportunities which allow for and therefore can justify this new capital. Nonetheless it remains imperative to ensure that the managers have the requisite skills in their specialised area and are able to deploy sufficient capital in a timely manner to both provide investors with liquidity and diversification. Through our investment research we continually seek to identify these opportunities and believe that despite the overhang of potentially challenging and protracted Brexit negotiations certain areas of the UK property market remain attractive.

Mark McKenzie
Head of Alternatives Research 

Article first appeared in:

What Investment (in print on the 2nd August 2017)

Opinions, interpretations and conclusions expressed in this document represent our judgement as of this date and are subject to change. Furthermore, the content is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or a solicitation to buy or sell any securities or to adopt any investment strategy.

Thomas Miller Investment is the trading name of the businesses in the Thomas Miller Investment Group. This note has been issued by Thomas Miller Wealth Management Limited which is authorised and regulated by the Financial Conduct Authority (Financial Services Register Number 594155) and is a company registered in England, number 08284862