Deep Dive: Property markets in this recession are not like 2008

Property acting more like a bond

clock • 5 min read
Deep Dive Property: Not the same situation as 2008
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Deep Dive Property: Not the same situation as 2008

Fears of recession are increasing in most major economies, with the US already in a technical one, and when the property sector is thrown into the mix flashbacks to 2008 occur. But going into this recession, experts told Investment Week that property is in a very different state than it was pre-GFC - in a good way.

Philip Matthews, the manager of the Wise Multi-Asset Income fund, went so far as to say: "We believe any comparisons to the performance of the sector in 2007/8 are misplaced."

He explained heading into 2008 the sector had been bolstered by five years of significant growth in asset value, while shares sat at a premium to those inflated levels.

Running parallel to this, gearing within the sector reached "eye-watering levels that provided no downside protection", with some property portfolios yielding the same amount as a UK government bond.

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This is not the case today with many of those high yields coming down to more sustainable levels as a consequence of Brexit, Covid and retail headwinds.

Matthews was not alone in this stance as Tim Munn, chief investment officer at Mayfair Capital, echoed his confidence the property sector did not carry the same risks it did pre-2008.

According to him, the area is now far less leveraged and there are far fewer daily traded retail funds susceptible to investor redemptions.

"We will not see the forced sellers we have in the past," he said.

Property today

Examining property against today's macroeconomic backdrop of 27-year high inflation and the social and economic fallouts of Covid, Munn said it is "easy to become overly fearful and ignore the fundamentals" in uncertain times.

Property pricing is determined by two components - rents and yields.

Munn explained that, in theory, the latter should provide an indication of the expected rental performance prospects of an investment, although in his experience this is not always the case.

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The former is essentially the prospect for growth and is determined by factors such as the physical supply and tenant demand.

"There have been many past instances where rents and yields have been out of kilter, often for good reason. Real estate investors do not operate in a vacuum - they must be mindful of macroeconomic and financial conditions, as well as how property pricing sits relative to other asset classes."

Winners and losers

Taking the current top-down picture into account there will ultimately be winners and losers in property, even if it is not as intense as 2008.

Guy Morrell, the head of real estate investment at HSBC Asset Management, said "direct property markets have provided a safe haven during the turmoil that has impacted wider equity and fixed income markets.

"Concerns about inflation and rising interest rates, combined with a weak economic growth outlook, have resulted in double-digit declines from most equity and government bond markets during the first half of 2022.

"By contrast, the MSCI UK Monthly Total Return index, a measure of direct property in the UK, rose by 9.6% over six months ended June 2022, led by continued strong occupier and investor demand for logistics properties. Other direct property markets have also seen positive returns."

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Morrell said he had been loading up on US senior housing and self-storage segments as a result.

Another major selling point for property at the moment was the diversifying role it could play to equities in the place of fixed-income.

Year-to-date, the property sector has outperformed longer-dated UK inflation-linked bonds, and Matthews said the more defensive parts of the sector with rents directly linked to inflation had been particularly strong.

Morrell added he expected the interest rate rises to dampen demand from investors relying on debt to finance acquisitions, although this will take time to be reflected in direct property indices, which typically lag the transaction market.

"Based on current yields, which were already at or close to historic lows in many key markets, we believe prospective long-run returns from direct property will be lower than historic averages but still imply a reasonable premium over government bond yields in most markets," he said.

The relationship between companies and property has shifted too, as businesses reduced their bricks and mortar holdings to accommodate more employees working from home.

While this shrinking office trend has been ongoing since 2008, according to Munn, office employment has increased significantly, creating a degree of resilience against the fallout expected from post-Covid working patterns.

"Reassuringly, despite mounting economic uncertainty, tenants are taking new space, buoyed by a strong employment market and consequent war for talent."

He added: "While it is easy to understand a cautious and patient approach to stock selection amid increased economic and market uncertainty, the sector's strong occupational fundamentals should comfort long term investors.

"Given this, we feel any price correction will be short lived and the expected scale of reduction in pricing troubling many investors will not materialise - particularly for high quality assets."

But like any area of the market some areas faced bigger challenges than others.

What to hold

Industrial, residential, student and healthcare all face structural tailwinds, according to Matthews, and have reduced the historic sector concentration to more cyclical retail and office markets. The online retail penetration plus more work-from-home demands added further challenges.

There have also been concerns about illiquidity in some areas, especially direct property, which Oli Creasey, property research analyst at Quilter Cheviot, did not think were unwarranted.

"We do not dismiss these concerns but note that they do not have to impact performance, which is delivered without the volatility of closed-ended structures.

"The L&G UK Property fund is best in class, if you can see past the illiquidity that comes with it."

He also recommended some hybrid funds, including BMO Property Growth and Income or TIME Property Long Income & Growth, to offer "the best of both worlds", providing direct property exposure with a portfolio of REITs which allows the funds to maintain liquidity in the majority of scenarios.

The aforementioned portfolios were ideal for gaining exposure across UK subsectors, but Creasey said there was value to be had in more specialist names, including Segro, a UK REIT with logistics properties throughout Europe.

"It has performed fantastically until recently, when offhand comments from Amazon caused ripples that impacted all industrial REITs.

"The impact makes little sense to us - this is an industry still very much in growth phase and with historically high levels of demand for the assets. We struggle to see why such a company is trading below NAV."

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