Increasing exposure to Europe, investing in property equities and remaining cautious on UK retail are some of the best ways to avoid the headwinds facing the world of property investing, according to Marcus Phayre-Mudge.
The manager runs the £1bn TR Property Investment Trust, which invests in Pan European equities and UK direct property. It’s benchmarked against the FTSE EPRA/NAREIT Capped index, which has an approximate 40 per cent weighting in UK equities and 60 per cent weighting in continental Europe.
While the trust currently has 55 per cent of its portfolio in the UK and 45 per cent in Europe, the manager attributes this UK overweight to its 9 per cent weighting in physical property in the south-east of England including the Colonnades, a large mixed-use block in the centre of Bayswater, London.
The manager is currently bullish on the property sector in general, due to the fact that equities don’t look too expensive and neither of the “big bear drivers” are currently in the markets.
Performance of sectors vs index
Source: FE Analytics
The first of these potential drivers, he says, is when markets rally hugely on the back of bank loans, and the second is when, as a consequence of too much money circulating in the economy, there is too much property development and not enough consumer demand.
Despite the property market being void of either of these headwinds, there are still areas that he believes it is important to avoid.
Some investors have become worried about the immense popularity of property markets pushing up prices, for instance, and the inherent illiquidity of the asset class.
In an article published last month, City Financial’s Mark Harris told FE Trustnet that investors should be cautious on buying into direct commercial property funs due to the strength of their recent returns and the amount of money that has flooded into that area of the market.
“The risk with property funds, as we all know, is liquidity. If people do think, ‘it’s all done and I want to get out’, that could be interesting,” he said.
“I always find it fascinating, and it’s just a casual observation, whenever money is just flowing into one area and it’s described as the ‘no-brainer’ investment or the ‘obvious trade’ – that’s often close to the peak.”
Interestingly, when Phayre-Mudge joined the team at TR Property Investment Trust in 1997, it had a 35 per cent exposure to direct property. This exposure fell to less than 15 per cent by 2005, and has been in the range of 7 to 15 per cent since.
“Generally our physical property exposure increases when equities become expensive relative to property and because our physical allocation is close to 10 per cent, that’s an indication that I don’t think the equity market is that expensive,” he said.
“To me, the listed companies in the UK don’t look overvalued. Because we’re buying our physical property in the UK, we are making that comparison between the two. But we tend to hold our physical for a long while – we’re not traders in the physical area of our portfolio.”
There are indeed headwinds for some property equities though, according to Phayre-Mudge. Despite his bullishness on supermarkets in central London, it is an area of the market that he generally doesn’t like.
It is well-known that supermarkets have endured a torrid time over the last two years due to aggressive price wars and plummeting sales.
However, Phayre-Mudge says that the increasing popularity of online shopping and the evolution of smartphones has also contributed to the problem.
“Realistically, you now don’t need to go to a shop ever again if you don’t want to, and therefore shopping no longer becomes a necessity, and area that becomes really visible in is supermarkets,” he said.
A second headwind facing the retail sector, according to Phayre-Mudge, is that consumers expect more from their shopping experience now, and will prioritise better food and beverage outlets, larger car-parks and nicer surroundings. As a result, it has become an expensive area of the market.
One way to side-step this though, according to the manager, is to turn to the retail space in Europe, which he is currently overweight in versus the benchmark.
“Europe is different because, given our central issue is the challenge of the internet, there is far less sophistication and depth of purchasing via the internet in continental Europe at the moment. Sweden is an exception but, for the bulk of it, they’re miles behind,” he explained.
“What we know is that rent, footfall and land turnover is still growing in European shopping centres, far more than the UK.”
Phayre-Mudge also believes that the residential market in Europe is riding on various tailwinds, including the announcement last month that Draghi would continue to deploy quantitative easing in Europe, which should provide a boost to the market.
Performance of index in 2015
Source: FE Analytics
Another reason is that there is greater rental culture in Europe, particularly in the likes of Germany – approximately 14 per cent of the fund’s assets are currently German.
“The German economy is doing well, wages are rising, employment levels are very high and an awful lot of people, far more than in the UK, rent their home rather than own it. So you’ve got this big deep pool of tenants and therefore rental companies have lot of granularity of income,” he explained.
“Even if a few people are losing their job or having to move, there are other people that want to move in and generally the income stream in the asset class is very secure. More importantly, it’s rising at around 2 to 2.5 per cent per annum and, because these people are in jobs, they can afford to pay a rising rent.”
The manager is also particularly positive on Sweden and Spain, due to economic growth and strong balance sheets, and the fact that there is very little new construction that hasn’t already been pre-let.
Despite this, Phayre-Mudge hasn’t given up on UK residential property either, and is bullish on London property over the long-term.
Over the next couple of years though, he says there are a series of headwinds on the horizon that investors need to be wary of.
The first of which is that the higher end of the market, which the manager constitutes as more than £1, 500 per foot, is slowing significantly. He partially attributes this to the large amount of foreign buyers purchasing secondary property in the area, and the economic headwinds they are having to face in their home countries at the moment.
“The question remains about what they’re going to do with the travails still remaining at home,” he said.
“Another headwind is that sterling has strengthened which makes it more expensive. Thirdly, stamp duty is a problem, and fourthly there is a lot of supply entering the market over the next few years.”
Because the population is growing and the UK still isn’t building enough housing, Phayre-Mudge says that there is likely to be a pullback in the pricing of new-build expensive apartments over the next couple of years.
Outside of London, the manager is finding lucrative opportunities in land manufacturers, who prime land and gain planning permission before selling it onto developers. One such stock that he holds is St Modwen Property, which specialises in the regeneration of brownfield sites.
“Rather than buying all the ingredients for a casserole and having to cook it for three days, you just want it instantly, and that’s what these companies do,” Phayre-Mudge explained.
“More and more property developers like to buy the land with the planning permission from these companies, as they also removed part of the risk involved in the process.”
TR Property Investment Trust has been in the top decile over one, three five and 10 years for its performance, returning 168.17 per cent over the last decade compared to its sector average of 134.55 per cent.
Performance of trust vs sector over 10yrs
Source: FE Analytics
It is also in the top decile for its annualised volatility, its risk-adjusted performance which is measured by its Sharpe ratio, and its maximum drawdown over the same time period.
The trust is 14 per cent geared, yields 2.6 per cent and is trading on a 5.1 per cent discount. It has ongoing charges of 1.57 per cent including performance fees.
