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Head to head: Lost property

Rogier Quirijns of Cohen & Steers and Rathbones’ Craig Brown on the outlook for the property sector

Rogier Quirijns and Craig Brown


As an asset class, property has long divided investors. While the so-called alternative asset is considered a genuine diversifier to equities and bonds, illiquidity issues in open-ended funds have meant a torrid time for direct property funds in recent years.

Following Brexit and during the Covid pandemic, many open-ended funds were forced to suspend dealing to stem the outflows as investors panicked. As a result of weakening sentiment, the number of property authorised investment funds in the IA universe has slowly dwindled, with Aegon and Aviva taking their products off the market in 2021, and Janus Henderson liquidating its strategy in 2022.

It’s no surprise then that both the IA UK Direct Property and Property Other sectors look weak, with respective net retail outflows of £253m and £136m in 2023. This negativity has carried over into 2024, with £41m of outflows from UK Direct property, versus redemptions of £109m in the Property Other category.

So are investors right to be turning their back on the asset, or does it still deserve a place in portfolios? This month, Rogier Quirijns and Craig Brown go head to head.

Rogier Quirijns, head of Europe real estate, Cohen & Steers

Global real estate is emerging from one of the most challenging environments we’ve experienced in more than 40 years, during which time we’ve seen the largest and fastest interest rate increases. Today, we believe listed real estate is in a better situation as both interest rates and inflation have peaked.

Meanwhile, bond markets have opened up again and as real estate investment trusts (Reits) have relatively strong balance sheets, benefiting from both lower finance costs and good access to equity markets, they can regrow their earnings.

In Europe, we are seeing low economic growth and inflation hovering around the 2% mark, an historically attractive entry point for listed Reits. Meanwhile, private valuations are correcting in Europe and globally, whereas Reits have largely already corrected and are trading at significant discounts, hitting their troughs in October 2023.

Right now, we believe there’s an attractive opportunity to add or increase allocations to listed Reits as we move towards a more accommodative macroeconomic environment. Historically, Reits have outperformed when yields are likely to move lower and are traditionally undervalued compared with equities.

See also: Head to head: It is time to reassess UK plc?

It’s important to note that while Reits have begun to recover, posting strong returns at the end of 2023, we believe the rally has more room to run and that Reits are still priced attractively compared with equities and bonds. We predict most Reits can grow their earnings again and are relatively defensive or resilient from a cashflow perspective.

Because we are expecting slow growth in Europe compared with the US, we prefer more defensive sectors, those with a relatively high implied yield or more cyclical sectors that are attractively priced with strong pricing power. We are finding a balance between long- and short-lease-duration property types, as well as defensive and more cyclical businesses with strong balance sheets. Our positioning is differentiated more by property sector than by country, based on common drivers affecting property types across the region.

Some sectors we currently favour include high-quality continental retail, which offers attractive valuations and solid fundamentals, as well as logistics and self-storage, which have structural growth characteristics and tend to be more cyclical.

We also hold exposure to UK long-income, inflation-linked stocks and European cell-tower companies, as we believe they offer protection against inflation and slower economic growth.

Another property type that fits more into the defensive sector thesis is German residential real estate, which we believe can provide a secure rental stream and has become more institutionalised over the past 15 years. It is significantly under-rented, over-regulated and under-supplied. Overall, we think German residential is the most resilient property type that is currently bottoming out in the direct market at a net rental yield of about 4.25%, providing 2-5% rental growth.

Because there are so many subsectors within real estate, with the diversification being one of the key benefits of the asset class, active management can make a difference when investing in listed real estate. Active managers can leverage their deep understanding of the market to take advantage of stockmarket volatility and pricing inefficiencies often created by passive strategies or passive flows. Active managers are also able to readily adjust allocations by property type and geography based on market themes.

Craig Brown, senior multi-asset investment specialist, Rathbones Asset Management

In the world of physics – admittedly not everyone’s cup of tea, but please entertain the nerd in me – there’s a thought experiment called ‘Schrödinger’s cat’. It’s an off-the-wall observation about quantum physics which points out, in simple terms, that if you place a cat in a box with something that has a 50/50 chance of killing it and then seal the box, theoretically the cat is both alive and dead until you open the box and see.

You may wonder what this has to do with property, but bear with me. This thought experiment feels a bit like what I see in some less liquid, more ‘subjectively valued’ assets. Like a cat in a sealed metal box, anyone running the box may tell you the cat is right as rain. But with much higher bond yields and the risk of souring economic sentiment, there certainly feels like there’s a greater-than-even chance that the cat ain’t happy.

Over the past decade or so, many investors have moved into these esoteric or alternative spaces to add diversification to their portfolios. While on the surface these assets can provide optical diversification during benign markets, when times get tricky that diversification tends to melt away.

Property is a good example of this. Property funds tend to be revalued relatively infrequently, and in brighter economic times they usually go steadily higher because they are valued largely by professional estimates rather than by the vanishingly few actual sales that complete. This tends to draw in more people who want a piece of those steady, ‘low-volatility’ returns. Yet the rub comes in times of trouble.

As alluded to earlier, the problem with property funds is that the underlying values of their portfolios are measured mainly by estimates during the good times. When economic shocks arrive and property owners need to sell pronto, these valuations tend to shift sharply closer to actual observed transactions, which are at bargain prices because of the stressed environment. I think of this as the moment when property funds open the box, if you will, when reality hits those valuations, and the cat really hits the fan.

See also: Head to head: On the bond wagon

Ultimately, our multi-asset funds team doesn’t use property to diversify equity risk because, as has been the case almost every time we see economic stress, it’s destined to be a disappointment. If there are few transactions to observe, it diminishes the reliability of the valuation in question. If you own property, then we believe it should be considered a cyclical asset.

In the investment trust world, the net asset value (NAV) of the underlying assets essentially means another closed box. Investors trade the shares of the investment trust daily though, so the price can move to a discount or premium to the last calculated NAV, showing what investors really believe the value of the box to be. Some discounts to NAV in this space look optically appealing, yet the question remains: are they real discounts, or will the cat be ‘dead’ when the trust’s assets are sold?

Many yield-hungry people bought these sorts of assets when once they might have bought more vanilla things, like corporate bonds, or even government ones, simply because the yields on offer were so dismal. Some investors will now be asking themselves: ‘Why take all this esoteric risk if I can start to get better yields for less risk elsewhere?’

Those old vanilla assets suddenly look more appealing. While we didn’t get on board the alternative income bandwagon, we do find the yields on government and corporate bonds appealing now that the risk/reward calculus has meaningfully shifted.

In the spirit of keeping things simple we adopt the ‘duck test’ for diversifiers. ‘If it looks like a duck, swims like a duck and quacks like a duck, then it probably is a duck.’ So if something behaves like an equity in stress, and isn’t very liquid in stress, chances are it should be classed as an equity-risk asset.

This article was written for our sister title Portfolio Adviser’s May magazine

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