Commercial Property update
There has been a great deal of press coverage over the last few days regarding the impact of the EU referendum result on UK commercial property, both at a market and a fund level. Sentiment towards the asset class is now negative, with a large number of predominantly retail investors looking to sell their holdings. Due to the illiquidity of commercial property this has caused market disruption, with several open-ended property vehicles closing to redemptions in order to protect existing investors. This prompts the inevitable question: should we be seeking to reduce allocations?
In our view, the impact on prices of this ‘dash for the exit’ discounts a fairly severe economic downturn. This is out of line both with the response elsewhere and expectations within the industry. The consensus among the fund managers we have spoken to is for a 4-7% fall in commercial property prices as a consequence of Brexit, with prime central London offices faring worse, falling by 10-12%. However, much of this has already been reflected in the pricing of our recommended funds: our favoured open-ended vehicles (OEICS and unit trusts) have lowered unit prices (either by moving from offer to bid pricing or by implementing a market value adjustment) by an average of c7.5%. Meanwhile, our recommended property investment trusts are currently discounting a c19% fall in the value of their underlying assets. We therefore believe that the forecasted effects of Brexit are broadly (and in some cases excessively) reflected in prices, while the weakness of sterling may well attract interest from overseas investors as prices fall, providing a floor for asset values.
Our decision in the Spring to reduce property allocations to an underweight position in anticipation of the risks posed by Brexit has proven prudent. In our view, the greatest risk now comes from the downward pressure on prices that would be caused by open-ended property funds being forced to sell assets at distressed prices in order to meet redemptions. It is to avoid precisely this outcome that several funds have temporarily suspended trading and, although it may be frustrating for investors, we are supportive of this move. Furthermore, over the past year we have been favouring closed ended investment trusts relative to open ended funds. These are not forced to dispose of holdings in a falling market to meet liquidity requirements.
The volatility that has arisen in the commercial property market is notable; however, we believe that the negativity associated with Brexit is, in many cases, more than reflected in prices. Given our long term investment horizon and value-orientated approach, we do not believe we should be swayed by short term changes in sentiment. While there will no doubt be further fluctuations in prices, the fundamental case for a modest allocation to commercial property remains intact. Supply is constrained, vacancy levels are low and, on an average yield of c5%, the income profile is attractive relative to other asset classes. We are therefore comfortable maintaining this exposure for the time being, however we will be in touch should our outlook change.