Deep Dive: Property in a post-pandemic world

With government bond yields in the US and UK yielding 1.3% and 0.6% respectively, lower than where they started in 2020, and corporate bond spreads narrowing to levels below those seen pre-Covid, the search for sustainable yield in global asset markets has once again become very challenging. Against this backdrop, the hunt for yield is pushing investors further up the risk curve, while pricing suggests investors accept the benign view that current levels of inflation will not persist.

The question now is whether there remain any areas to invest where yields remain attractive, economic recovery is not fully reflected in valuations, and which provide some protection in the event inflation proves less transitory than expected. One sector that fulfils these three criteria is property.

Property shares generally sit well below pre-Covid levels – there is no doubt the pandemic has impacted the outlook for demand. Working from home has changed from being something the lucky few could arrange on a Friday to a necessity likely to endure well beyond everyone’s second vaccine jabs. The long-term impact of a paradigm shift in working on the office market will need to be carefully considered.

Meanwhile, care homes were in the eye of the storm during the first lockdown and occupancy fell as families were either reluctant to put relatives into care homes or a backlog in NHS referrals limited access for new residents. Hospitality also had to weather the tempest; funds with exposure to hotel assets were particularly hard hit. Encouragingly signs are emerging that investment demand is returning directly for these assets that is not being reflected in quoted shares prices, which sit at discounts.

Understanding the new normal

For investors, the outlook for commercial property will depend on the extent to which underlying occupancy returns to normal or whether Covid has permanently changed what ‘normal’ will resemble. Will previous structural tailwinds, such as an ageing population for the care sector, reassert themselves or
will the disruption from Covid prove more protracted?

We are finding a diverse set of opportunities within the sector to invest in companies offering high initial yields, which, in some cases, already reflect lower levels of income received last year.

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Ediston Property, an investment trust predominantly exposed to retail parks, currently yields 6.7%.  However, we believe the dividends have ample opportunity to grow from here as tenants return to paying rent that was foregone during the crisis. Similarly, the Standard Life Investment Property Income trust yielding 5.1% and on a discount of 19% looks attractive.

Impact Healthcare REIT offers more direct inflation protection. Impact Healthcare REIT’s portfolio constitutes 109 care homes let to 12 tenants and two healthcare facilities let to the NHS and has seen strong rent collection with 100% of rent collected over the course of the past 12 months.

Deep Dive: Property in a post-pandemic world

An improving picture

Occupancy trends are improving within their care homes – and with rents having inflation linkage built in, an initial yield of 5.5% looks compelling. Higher up the capital structure, the risk-reward dynamic at Starwood European Real Estate Finance looks attractive.

The company represents a diversified portfolio of real estate debt investments in the UK and continental Europe. Unlike other areas of corporate credit, the company has not regained the levels seen pre-crisis and sits at a 6% discount to net asset value, whereas pre-crisis it traded at a premium.

The exposure to hotel assets explains investors applying a greater discount to the shares. However, the recent announcement that their largest loan to a Spanish hotel operator had been repaid in full is testament to the real risk investors are exposed to and the conservative asset-backing that underpins
these loans.

Closed-ended funds offer an appropriate way to invest into this sector which avoids the liquidity mismatch of open-ended funds. There remain excellent opportunities to gain more cyclical exposure where recovery is not being priced in as well exposure to more defensive areas. Initial yields are high and have scope to grow either through the indexation of rents or as rental income grows from pandemic troughs.

Philip Matthews is co-manager of the TB Wise Multi-Asset Income fund

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