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Shops and offices have been shuttered

Commercial property has been one of the hardest-hit sectors during the pandemic, and received the unenviable accolade of being the worst-selling open-ended asset class of 2020.
Retailers were forced to close their doors for more than half of the year, …

Commercial property has been one of the hardest-hit sectors during the pandemic, and received the unenviable accolade of being the worst-selling open-ended asset class of 2020.

Retailers were forced to close their doors for more than half of the year, and still remain shut today - while offices have sat largely empty as millions of British workers abandoned their commutes and worked from home.  

According to data from consultancy business the Future Strategy Club, a quarter of London office workers have not been back in the city since the first lockdown in March 2020, while 60 per cent are tempted to leave the nine-to-five lifestyle for good.

Many insist illiquid assets such as property are better suited to a closed-ended fund structure

Many insist illiquid assets such as property are better suited to a closed-ended fund structure

Meanwhile, rent collection has been under the spotlight. The enforced lockdowns prevented tenants from using their properties, and some chose to withhold rental payments from landlords, with the biggest drop in rent collections seen in retail, hospitality and leisure.   

In reports published late last year, commercial property owners claimed Boots Opticians, restaurant chain Nando's, dentistry chain My Dentist and sandwich shop Subway were among many other big corporations paying little or none of what they owed.   

Challenges in the office and retail space within commercial property were reflected in open-ended fund flow figures for 2020, with property funds seeing outflows of GBP291million for the year, according to the Investment Association.

This was despite most open-ended property funds being closed for most of the year, as rocked investor confidence led to mass withdrawals. Three such funds are still yet to open.

In comparison, equities enjoyed positive inflows of GBP10,410million over 2020.

Fixed income funds saw inflows of GBP7,963million, and even money market products saw GBP3,002million.

Closed-ended funds performed better

On the closed-ended side however, property trusts enjoyed modest inflows. 

Last year, the Association of Investment Companies' UK commercial property sector attracted GBP732million in secondary fundraising. Since the start of 2021, it has raised a further GBP32million.

Chief executive, Ian Sayers, said: 'With most of the major open-ended property funds suspended for the majority of 2020, it's encouraging to see more investment in closed-ended property investment companies which are particularly suitable for illiquid assets like property.' 

However, UK commercial property trusts tend to be focused on less traditional types of property rather than your average office building or retail store, which are more commonly seen in open-ended property funds.

Secondary fundraising in the AIC Property - UK Commercial sector  Investment trust  Secondary fundraising total (GBPm)
Supermarket Income REIT 339.82
Urban logistics REIT 225.81
Warehouse REIT 153.00
AEW UK REIT 7.00
Custodian REIT 5.68
Standard Life Investments Property Income 0.96
Secondary fundraising from 1 January to 31 December 2020. Closed issues admitted to trading only. Excludes VCTs and shares reissued from treasury.

Source: AIC/Morningstar.

The most popular trust for raising funds in the sector in 2020 was the Supermarket Income REIT, which raised GBP340million, making it the fourth-highest secondary fundraise across all investment trusts across the year.

The trust, which is up 6.7 per cent compared with 12 months ago, does what it says on the tin and invests in supermarkets. These performed well during the pandemic as people took to stockpiling ahead of lockdown fears.

This was followed by Urban Logistics REIT and Warehouse REIT, which raised GBP225million and GBP153million respectively. Again, this is an area of the market that has performed well due to the boost in online shopping and therefore the need to store and sort goods for delivery.

Investing experts say the popularity of closed-ended property funds is due to the the investment trust structure being better suited to illiquid assets such as buildings.  

The AIC's Brodie-Smith said trusts are better suited to illiquid assets such as property

The AIC's Brodie-Smith said trusts are better suited to illiquid assets such as property

Annabel Brodie-Smith of the AIC said: 'The past year turned the idea of the office on its head, and there's still much uncertainty as to what the future looks like.

'However, investment trusts in the Property - UK Commercial sector offer investors access to a wide range of different property types, from city centre and regional offices to supermarkets and factories.

'Their strong fundraising reflects the themes which have thrived over the past year and proved a lifeline through lockdown living, such as supermarket shopping and warehouse properties to fulfil online retail.' 

A new growth market 

Laith Khalaf of AJ Bell agreed that the commercial property trusts which raised the lion's share of money in 2020 were in sectors which thrived in the face of the pandemic - namely supermarkets and e-commerce. 

'As well as traditional commercial property funds, investors now also have access to this new breed of trusts which target specific areas, including online delivery logistics, which is clearly a growth market,' he said.  

Meanwhile, Jason Baggley, manager of the GBP250million Standard Life Property Income Trust, said it was an example of real estate evolving as our lives and the way we lead them evolved.

He argued that the trends we are seeing now have been happening for some time, with the pandemic only accelerating them.

For example, changes in the way we shop have fuelled the move from retail stores to warehousing and other areas of logistics, which has in turn been driven by technology. 

'Technology also drives changes in how we use offices,' said Baggley. 'We don't believe the office is dead, but there will be a reduction in demand and the way we use them will evolve. 

'Beds is a new investment class for the UK and growing in importance - be it purpose-built student accommodation, age care, or build-to-rent living. Society demands greater levels of service, and so the space we provide is changing, with a  greater amenity offer.

'Meanwhile, Covid and Brexit will play equal roles in bringing more attention to supply chain management - and might lead to even greater demand for industrial and logistics space.'

Property funds or trusts? 

Industry figures have long campaigned for all types of property and other illiquid assets to be solely available in a closed-ended structure. 

Brodie-Smith said trusts had a much more suitable structure for investing in hard-to-sell assets such as property. 

She added: 'The structure means managers don't have to worry about inflows and outflows, and their stock exchange listing means investors can buy and sell shares whenever the market is open, without the risk of suspensions.'

This eliminates worries over liquidity mismatch, meaning an investor can sell shares without the trust having to sell a building to meet the liquidity - as is the case in open ended funds. 

Open-ended fund managers try to mitigate this by holding around 20 per cent of the fund in cash or very liquid investments. 

But when everyone tries to leave at the same time, that cash can run out, which leads to suspensions, as was last seen in 2016 after the EU referendum result.

It is worth noting, however, that last year's suspensions were triggered by 'material uncertainty' in property prices, as lockdown restrictions meant property could not be valued as it normally would be.   

So why are open-ended funds still the more popular choice of fund structure when it comes to investing in property?

Some of the biggest funds are on the open-ended side, such as Janus Henderson's UK Property fund at GBP1.8billion or the L&G UK Property fund at a whopping GBP2.9billion.

Khalaf said: 'On balance, closed-ended vehicles are preferable for commercial property investment, but open-ended funds are more popular because they're familiar to investors, and in theory have a simpler pricing structure, though in practice that's debatable. 

'The FCA is consulting on imposing a 90 to 180 day notice period for withdrawals for unit trusts, which if implemented could swing the pendulum towards the closed-ended sector. 

'However, because investment trusts price throughout the day, they still pose challenges for some commercial property investors, for instance regular savers who want to pay a monthly sum into the sector.' 

Suspended open-ended UK property funds in 2020  Fund  Launch Date Fund Size (GBPm) Reopening date
Aegon Property Income 07/09/2020 409 Still closed
Aberdeen UK Property 29/11/2018 718.8 16/11/2020
Aviva Investors UK Property  18/08/2017 380.3 Still closed
BMO UK Property 28/06/2010 348.6 14/12/2020
Janus Henderson UK Property PAIF  01/08/2012 1834 Opening 24/02/2021 
L&G UK Property  28/02/2006 2865.7 13/10/2020
Canlife UK Property 02/07/2018 316.6 08/10/2020
M&G Property Portfolio  03/08/2012 2084.8 Still closed
Royal London Property  01/05/1991 397.7 30/09/2020
Standard Life Investments UK Real Estate  22/12/2004 1437.4 16/11/2020
Threadneedle UK Property Authorised Investment  13/05/2016 725.4 17/09/2020
Source: AJ Bell. All figures accurate as at 18 February 2021

Discount risk

Discount is where the value of the trust's shares are below the value of the trust's investments.

This was definitely an issue in 2020, as many property trusts swung to large discounts and remain significantly wide.

For example, the BMO Real Estate Investments trust is currently trading on a discount of 22 per cent, while the SLI Property Income trust has a discount of 24 per cent.  

Darius McDermott, of Chelsea Financial Services, said: 'One of the cons of the investment trust structure is the price is very volatile when there is stress in the property market. 

'Both following the Brexit referendum, and earlier in 2020 with the material uncertainty caused by Covid, the investment trusts traded at a large discount which meant you can sell your trust but you would get back less than the net asset value.'

In terms of performance, the average UK commercial property trust was down 15 per cent over 2020 while the average UK commercial property fund was down 3.5 per cent.

McDermott added: 'Diversified property funds outperformed similar investment trusts last year due to the discount mechanism. 

'When more investors want to sell than buy, the trusts trade at a discount and this affects the total return you get.'  

Only five of the 16 trusts in the Property - UK Commercial sector are currently trading on a premium, including the successful fundraiser Supermarket Income REIT. 

Retail warehousing is on the 'right side of change'  

The GBP148million Ediston Property Investment Company launched in 2014, when there was a positive outlook for commercial property. 

It launched with four offices and one retail warehouse park, and the portfolio has grown to encompass four offices, two leisure units and 10 retail warehouse parks today.

Ediston Property has more than half its portfolio invested in retail warehousing

Ediston Property has more than half its portfolio invested in retail warehousing

Manager Calum Bruce said retail warehousing was often lumped together with high street shops and shopping centres, but it should be considered independently. He argued that it boasted huge benefits, which have only been highlighted during the pandemic.

He said: 'Retail warehousing has embraced the internet and the increased demand for online shopping. It is the ideal platform for retailers to fulfil their omni-channel strategies through click-and-collect and home delivery.

'But the property market is cyclical, and different sub-sectors will be in or out of favour at different times.

I do not think it is fair to say that offices have been shunned in favour of industrial and logistics.

'There is no doubt that the demand for industrial assets has increased in recent years, leading to yield compression - but there are still investors who see better value in offices (and other sectors) and would prefer to own them rather than industrial. 

'Ultimately it comes down to stock selection and acquiring the right asset in your sector of preference, in accordance with your risk profile.'

Ediston's Bruce said there were still reasons to be positive about commercial property

Ediston's Bruce said there were still reasons to be positive about commercial property

Commenting on the withholding of rental payments by retailers last year, Bruce said while there were tenants who clearly needed cash flow assistance, there were other well-funded tenants using the situation to their advantage and still refusing to pay rent. 

The situation was not helped by the Government's moratorium on the use of the usual rent arrears recovery methods which are usually available to landlords. 

'This removed any 'teeth' landlords had to recover arrears,' said Bruce.

'We took a hands-on approach to arrears recovery, and formed a rent collection team to engaged with as many tenants as we could. 

'We worked with those tenants who were struggling to try and find a way through the crisis. Our approach worked, as we collected 89.3 per cent of the rent billed for our financial year which ended on 30 September 2020.'

Despite the challenges the sector has faced in recent years, Bruce believes there are still many reasons to be positive about the future of commercial property.

He said disruption created uncertainty, but uncertainty created opportunities, and added that it was important to be on the front foot and to move quickly and take advantage when they appeared.

Bruce said: 'It has taken a pandemic for investors to differentiate between the retail sub-sectors, but we are now more convinced than ever that retail warehousing is on the right side of change.' 

2021 outlook

Most of the open-ended UK commercial property sector is now back open for business after spending large parts of 2020 shuttered. 

Brexit still poses a risk to the sector, but Khalaf suspects that it 'will be water off a duck's back compared to the pandemic'. 

'Open-ended funds are holding lots of cash which should give them a buffer if we see rising redemptions again, but equally that money isn't exactly working hard for investors with interest rates at record lows,' he said.  

Looking at the sub-sectors within commercial property, there may well be some bounce-back from the retail sector if the economy opens up again. However, it won't entirely repair the damage as the industry continues to suffer a longer term decline at the hands of the booming digital economy. 

AJ Bell's Khalaf thinks open-ended funds are more popular because they are familiar

AJ Bell's Khalaf thinks open-ended funds are more popular because they are familiar

Khalaf added: 'That ill wind for the retail sector blows a great deal of good for commercial properties servicing online delivery. 

'There may be a pause for breath after a year which has been dominated by online shopping, but in the longer term it's clear which way the tide is moving. 

'Office space has also been put on the ropes by the pandemic.

Again, if all goes well with the vaccine rollout, the easing of social restrictions should mean growing confidence in the office sector - but the longer-term picture is likely to be marred by companies reshaping their physical footprint to make way for more working from home.' 

Meanwhile, the very low interest rate environment means the relatively secure and high yield from real estate will remain attractive.

Baggley said he saw a 'considerable weight of money available to invest in the sector'. 

He added: 'Although the medium term looks supportive, we need to be cautious about the impact of the economy in the short term. 

'As structural changes continue, I would suggest investors support research-based active managers positioning for the future.'