Property investors who were caught out after the EU Referendum in 2016 are taking measures to protect themselves as the date for Brexit approaches.
The result of the referendum two and a half years ago raised fears that the UK property market could plunge, and panicked investors quickly looked to offload any holdings they had in the sector.
Property funds suspended trading so that managers were not forced into a fire sale of their assets while real estate investment trusts and property companies suffered share price collapses of as much as 70%. In many cases, it would be months before trading normalised.
While a number of investors have tentatively returned to the sector, many of these will be seeking reassurance from managers that the same panic will not ensue when the UK actually leaves the EU.
Property fund managers have a handy tool in that they can gate their funds if they are concerned about mass redemptions, but this is usually a last resort for companies as, understandably, unit holders don’t like it.
As a result, many of these funds are holding higher amounts of cash than they might have historically to ensure they have enough liquidity to deal with any surprise outflows without having to sell assets.
Ainslie McLennan, manager of the Janus Henderson UK Property Paif currently has 18.6% of assets in cash and a further 4.2% in property securities. The fund has been reducing its exposure to offices in both the UK regions – excluding the South East – and in the West End of London. These tenants now account for less than 1% of the fund’s rental income.
Instead, McLennan is focusing on what she considers “Brexit immune” parts of the market such as care homes and data centres, which now make up around a third of the portfolio. These are driven by long-term trends – the ageing population and the growth of data – that won’t change regardless of the macro situation. She adds: “These properties typically have long leases with inflation-linked rent increases.” The fund is up 7.5% over the past year and has a 12-month yield of 2.3%.
Limited Change – For Now
Gerry Frewin, manager of the Threadneedle UK Property fund, is more sanguine about what Brexit means for the property market. He points out that tenants are tied into long leases, which they can’t exit without financial penalties, so there should be limited change in demand initially. He adds: “However, over time we may see more CVAs as a result of high street failure if the economy suffers.”
Frewin has no central London property in his portfolio and is focused on maintaining a diverse portfolio with a low vacancy rate. It currently holds 200 properties with around 1,350 tenants, with a bias towards industrial properties.
Around 15% of assets are in cash but Frewin sees this as a tool to take advantage of buying opportunities if there is a correction in the market rather than as money readily available for investor redemptions. The fund is up 6% over the past year and has a 12-month yield of 4%.
Using Cash to Buffer Risks
Justin Upton, co-fund manager of the M&G Property Portfolio, says: “Two years on from the referendum and commercial property is still delivering attractive returns. Despite the negative sentiment following the vote, the decision to leave the EU hardly made a dent in medium-term performance and by the end of 2016, capital values had all but recovered their summer losses.”
But the team has still taken steps to reposition the portfolio: the fund usually has around 7.5% to 12.5% of assets in cash but has currently upped this to 15%. The team have also increased their exposure to “prime, high quality” properties from around 45% before the referendum to 65% today.
There is now a greater focus on industrial space in the South East “where the supply/demand imbalance is most acute” and they have also added a position in student accommodation, which tends to hold up well in a downturn. Meanwhile, they are less positive about the outlook for office sector, with estimates that more than 100,000 City workers could be relocated to Europe post-Brexit.
The fund, which has returned 5.7% over the past year and has a 12-month yield of 2.4%, has been bearish on the outlook for high street retail for a number of years. The troubles of the sector are well-known, with the rise of internet shopping and demise of the high street largely to blame.
While higher levels of cash within property funds may be reassuring for investors who don’t want to end up locked into a fund, there is a major downside. Cash not invested can’t grow and so acts as a drag on returns.
Ben Yearsley, director at Shore Financial Planning, says: “Many direct property funds are now sitting with 20% of assets in cash. This isn’t great for investors as they are paying a full management fee for only 80% exposure and it highlights the deficiencies of open-ended property funds.”
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