The Investor Breakfast held on 25th January 2019, in association with the Real Estate Investors’ Forum and Property Match, to discuss what 2019 could hold in store for UK real estate was a tremendous success. The event was strictly for investors only and very well attended.
Melville Rodrigues, partner, Charles Russell Speechlys, welcomed everyone and was moderator for the morning. The topics for discussion were firstly, the differing pricing message from listed and unlisted real estate markets. This was to be covered by Nick Knight, Executive Director, CBRE Valuation Advisory, talking about the unlisted market, followed by Paul Robinson, Executive Director, CBRE Capital Advisors, covering the listed market.
Following this discussion, Dominic Smith, Head of CBRE Real Estate Analytics, looked ahead, sharing their forecasts for the market and addressing the question of whether the secondary market pricing was justified.
Melville then gave an overview of the important governance changes coming into force this year, following the FCA’s Asset Management Market Study.
For the unlisted market, Nick talked the audience through the returns for 2018, with the CBRE Monthly Index (a subset of the MSCI/AREF index) returning 6.3% for the year – mainly income return. The capital returns for sectors differed materially, however, with industrials returning 12.4%, offices 3.1% and retail -7.4% (two-thirds of the latter occurred in Q4 2018). Such a wide variance between sectors in the index has never been seen before.
Broadly speaking, all retail subsectors saw yields rise, offices were largely flat, in terms of yield movement and industrial tightened at least 50bp.
Transaction volumes overall were slightly lower than 2017 but remained ~30% above the ten-year average. Nick highlighted how the alternative sectors (outside retail, office and industrial) had continued to grow in share. Healthy volumes were not seen across the board though. Within the mainstream, retail volumes were around 33% lower than average, with shopping centres particularly low. This made valuing such assets particularly challenging due to lack of transactional evidence.
However, Nick emphasised that all assets are different. Within all the sub-sectors, the range of asset performance was very high. For example, retail warehouses had a range of returns from around +10% to -25%. He said there was an ongoing, welcome debate regarding the pace of change in retail values. In summary though, in the current market, given such a variance in returns, Nick warned against focussing on averages. Looking at 2019, he also highlighted the risk that political uncertainty could translate into reduced transaction volumes, making the valuers job more challenging.
Paul Robinson then took a look at the listed market, asking whether investors should read anything into the pricing there. At an index level, he showed how correlated REITs were to equities and had only underperformed the FTSE100 by 4% over 2018. That said, the correlation looks lower over a five-year period but neither the FTSE100 or UK EPRA REITs index had returned much for investors over the last five years either, on a close-to-close basis.
Paul then took the audience through closer look at the individual REITs and their various valuation metrics, explaining why he believes the current discounts to NAV do not tell much about valuations of the underlying assets. Rather, such discounts say more about company specific issues - for example, the state of the balance sheet.
That said, when CBRE have analysed the implied capital growth of the UK REIT index versus the MSCI/AREF index, the last year has shown a material difference in returns. Paul acknowledged the unlisted index is a more core asset base and does not have gearing which would account for much of this. However, he suggested the more likely answer was that perhaps both the capital return profiles were wrong.
In summary, Paul cautioned against reading too much into REIT pricing as these are indicative of market sentiment, macro and micro risks (the equity risk premium increasing) and reflects the cost of liquidity. He highlighted the variance in discounts too between sub-sectors; retail deeply discounted, industrial REITs at or close to book, London office REITs deeply discounted despite continuing strong underlying performance. They are conscious of the pricing in the listed market versus the unlisted but not alarmed.
During the following question and answer session, they were asked whether a delay to Brexit was likely to have an effect. Nick reflected on the shock of the referendum result in 2016 and how that caused a pause in transactions and how open-ended funds struggled at that time. In the first month or so, valuations dropped around 4% before the market got back on its feet and values eased back up again. The market is currently relatively stable, despite ongoing uncertainty around Brexit – it is no longer a shock. Perhaps the biggest risk to this though would be a ‘no-deal’ scenario.
They were also asked about the divergence within retail returns. Nick explained that shopping centres fell in value first but more recently retail warehousing has seen declines increase, more reflecting underlying passing rent evidence.
Dominic then took the audience briefly through the economic forecasts of CBRE and the resultant outlook for the real estate market in the UK. In summary, they believe there will be US-led global economic slowdown, there will be interest rate volatility but higher rates over five years, modest valuation declines in UK real estate, though he attaches greater significance to the current differences in listed and unlisted markets. Investors wishing to know more should contact CBRE Real Estate Analytics directly.
Melville then talked the audience through the regulatory changes UK authorised fund boards were having to deal with by September this year. Read our recent article on the subject here. Essentially, fund boards must appoint 25% of their board, or at least two, independent non-executive directors (iNEDs). The FCA’s aim is to improve transparency and better balance the interests of the fund investors versus the fund manger’s and its shareholders. This is something close to AREF’s heart, promoting best practice on governance and launching our Quality Mark last year – for details read here.
Melville explained how the US is way ahead of the game on this front, with more than 75% of mutual fund boards made up of iNEDs in 85% of fund complexes. Nearly two-thirds of the chairs are independent too. The catalyst for this change over the last fifteen years has been demand form the investors. Are these lessons for us in the UK, to transition to greater representation through iNEDs across all funds, not just the UK authorised currently required to do so, ahead of the regulator potentially mandating potentially cumbersome rules to do so? Melville directed the audience to the organisation UK Fund Boards, currently looking closely at these issues. Within AREF’s Code of Practice, iNEDs are regarded as ‘best practice’, rather than compulsory at this time (save for those UK authorised funds, where the new regulation will now take precedence). The Corporate Governance Committee is considering this new environment and will review the status quo.
AREF would like to thank all the speakers for making the Investor Breakfast so insightful, all the delegates for making it such a success and CBRE for being such excellent hosts. To keep informed of all the latest news from the real estate funds industry, please take a look at AREF’s dedicated webpage for investors, sign up to our monthly newsletter and follow us on Twitter and LinkedIn.