IW Long Reads: Keeping the door open - Does the open-ended property sector still have plenty to offer?
Sector sceptics could be missing out on opportunities
Open-ended property funds have been in the headlines for mostly all the wrong reasons for much of the past 12 months, as the sector has once again been held hostage by a large market sell-off, this time stemming from the Covid-19 outbreak.
Following a wave of redemptions, in March last year all UK physical property funds were forced to suspend dealing as independent valuers were hit by material uncertainty regarding valuations.
It is not the first time such measures have been taken; many funds took similar action back in June 2016, as investors rushed for the exit door after the UK voted to leave the European Union.
While such measures are designed to protect investors, it has led the Financial Conduct Authority (FCA) to look into the way open-ended property funds are structured.
In September last year, new FCA rules were introduced that meant funds would have to suspend any dealing where there is material uncertainty on more than 20%.
In August, the regulator sought industry consultation on proposed rules that would require investors to give notice - potentially up to 180 days - before their investment is redeemed from an open-ended property fund.
The result of this consultation, which could see property funds stripped of their eligibility in stocks and shares ISAs, is due imminently.
Given all this negativity, it is little wonder many investors have become sceptical of the asset class, but could such a stance mean they are missing out on investment opportunities?
"We believe in the long-term benefits of investing in bricks and mortar," says Richard Philbin, chief investment officer at Wellian Investment Solutions.
"Property as an asset class is a diversifier - the correlation of it provides the opportunity for the fund selector to build a portfolio with different characteristics to a traditional equity and fixed income mixture."
For Philbin, the important thing for investors to note when it comes to investing in property, is that it is not a "catch all" asset class, as the characteristics of investing in retail is different to that of investing in industrial units.
"The quality of the tenant, the length of the lease, the age of the building, the attributes of it and many other factors, such as asset management opportunities, are taken into consideration when investing," he says. "They are also factors in the price paid."
Not all property is the same
As a result, while Philbin says the potential for fund managers to add value for their investor base is there, he notes that not all property funds are the same.
"Due diligence on the funds you research is key to the process," he says. "Our favoured three funds are BMO UK Property, Janus Henderson UK Property and Time Commercial Long Income.
"Collectively these three funds diversify each other, with the BMO fund having very little exposure to retail and marginal exposure to central London and investing in mid-sized properties.
"The Janus Henderson fund meanwhile holds larger lot sizes and has more of focus on London and the South East, while the Time portfolio contains a mixture of ground rents and properties, and its assets are leased on much longer leases than your typical bricks and mortar funds."
However as with all investments, Philbin notes that property is a risk asset and is not without its quirks and volatilities.
"Treated primarily as a steady income proposition, but with the scope to add capital value, we believe property should be considered a core part of any blended portfolio even accounting for the problems over the last couple of years," he says.
He adds: "Although it is very much under the spotlight at the moment due to the referendum and the fallout from the Covid-19 pandemic, and the meteoric rise and subsequent fall of WeWork, it is an asset class that has the ability to transform and reinvent itself."
So where are the managers seeing the best opportunities within the asset class at present?
"With valuations bottoming out and rents rebasing, now is an opportune time to buy into retail parks," says Calum Bruce, investment manager of the Ediston Property Company.
"For a long time, retail parks were unjustifiably written off after being lumped together with high street stores and shopping centres under the retail property umbrella.
"However, we believe the potential of retail parks remains under appreciated, and demand will soon start to pick up as visibility is re-established in the sub-sector."
A stockpickers market
Amid heightened volatility, Rick Romano, manager of the PGIM Global Select Real Estate Securities fund, expects 2021 will be a year that rewards genuine stockpickers.
"We are balancing opportunities between companies with fundamentals benefitting from - or less impacted by - the current environment, with value opportunities in property types most negatively impacted,"
he says.
"As a result, based on fundamentals and valuation, we are overweight global last mile industrial, cold storage, global affordable and mid-level priced housing," he adds.
"We are also overweight gaming REITs, based on valuation and credit quality of both the tenant and the REIT. We are also finding some select opportunities in healthcare, hotels and restaurants."
Following news of the vaccine, Romano says some property types that were negatively impacted by the pandemic and shutdown in 2020, may now finally see a path to recovery.
"For example, there is undoubtedly pent-up demand for leisure travel and fundamentals for areas such as hotels are likely to markedly improve over the next 12 months," he says.
Ben Fry, investment manager of ReSI Capital Management and head of housing at Gresham House, believes property is not an asset class best held in an open-ended format, given its illiquid nature.
"The market is moving to open-ended structures that take time to provide liquidity. For retail investors wanting property exposure, investment trusts provide daily liquidity but without the investment trust manager needing to sell a portfolio's underlying assets," he says.
In terms of opportunities, Fry's focus is on residential property - in particular, mass-market, affordable housing.
"We see this as one the most underserved parts of the market," he says. "Within this, we are looking at three main areas: retirement living, shared ownership and affordable build-to-rent.
"The overriding message is that people have to have somewhere to live regardless of the economic environment and homes are now by far the most important things in people's lives."
Year of transformation
From home working to online shopping, Tom Duncan, senior associate at Mayfair Capital, says it is clear the post-Covid property market will be fundamentally altered as people make lasting change to living, work and leisure arrangements.
He argues this new environment will create opportunities for investors who are able to align themselves with these adjustments.
"We expect 2021 to be a year of transformation," he says. "The pandemic has accelerated many of the structural changes already underway, such as flexible working and the rise of e-commerce, and forced the evolution of business models.
"Last year was hard for many businesses, with high street retailers going bust and office lettings taking a hit, but it has brought forward much needed adaptation."
Given these changes, Duncan says flexibility will be prominent this year. He foresees more buildings using flexibility as the lines between office, retail, leisure and logistics assets blur.
"This year, we will see more offices pivot towards providing the type of amenity-rich, multi-functional and engaging space the new world of work demands," he says.
"We will see more failing retail parks repurposed for urban logistics or to provide much needed housing. We will see former department stores reimagined as co-working spaces, food halls or co-living developments. Last year's pain will allow us to gain from more purposeful and relevant real estate."
It was announced at the end of January that on 24 February the Janus Henderson UK Property fund will become the latest open-ended fund to lift its dealing suspension.
For fund buyers and buyers this is good news, Darius McDermott, managing director of Chelsea Financial Services, notes.
"To me, liquidity is key and there is now plenty of that," he says. "We now await the FCA's decision on its consultation into property funds. Hopefully there will be an announcement soon and the sector can move forward in whatever guise is necessary.
"For diversification and income reasons, I still believe the sector has a lot to offer investors."
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