How to solve a problem like liquidity: REITs and the UK property sector

Real Estate Investment Trusts (REITs) burst onto the UK investment scene in January 2007, sparking an immediate conversion of many of the UK’s largest listed property companies into the new structure. 

In short, a REIT is a closed-ended company which trades on public markets, providing tax efficient investment exposure to property assets.

UK REITs remain relatively small compared to more established sectors in the US and Australia. Nonetheless, it has shown remarkable growth, with changes to REIT legislation in 2012 further encouraging investment into UK property and boosting their popularity among investors. The attractiveness of a structure which offers exposure to property indirectly, without the liquidity issues of having to own the bricks and mortar assets themselves, has certainly wooed investors in the last decade. 

Structurally suited to provide liquid access to what is traditionally a highly-illiquid asset class, REITs can focus on long-term portfolio returns rather than short-term liquidity issues. They have become one of the best performing UK assets and over the past decade UK REITs recorded an annualised return of 9.7%*. In comparison, between July 2009 and July 2019 UK equities returned 9.1% a year, 10-year Gilts returned 8.5% and investments in the IA UK direct property sector returned 6.2% annualised. Furthermore, the dividend yield of the UK REIT index has outstripped inflation over the past decade, offering 4.0% per annum against inflation running at 2.2%.

As well as strong performance and regular income, REITs offer access to sector specialists who are experts in selecting the best assets to provide long-term, dependable cash flows. This is particularly beneficial when looking to invest in more niche areas of the market, such as real estate assets in the logistics, student housing or medical sectors. 

Extreme investor events, such as selling on mass, have prompted liquidity concerns which can impact the short-term share price of a REIT. Unlike exposure to direct property OEICs however, the end investor is protected from the potential of gating. 

In the wake of the Brexit referendum, some open-ended property funds had to close to investor requests and were forced to sell assets to raise cash to meet redemptions. This is something the newly launched VT Gravis UK Listed Property Fund (GULP) will avoid by investing solely in REITs and other, liquid, real estate securities.

The investment outlook

The strongest investment opportunities are those powered by favourable societal mega-trends such as the ageing population, generation rent, technological innovation and urbanisation. 

Demand for GP surgeries and medical centres is likely to increase dramatically as more people live longer. A third of 18-year-old girls today can expect to live into their nineties according to the Office for National Statistics, undoubtedly increasing demand for medical care and services.

Technological innovation on the other hand is powering the rise of internet shopping and the demand for next-day, or even same-day delivery of goods. This trend is powering the need for warehouses and logistics bases and opening up opportunities for investors to provide much-needed capital to support development. 

Being aware of these major trends is important when looking for REITs with the most promising potential for returns. Investors should look for key drivers of outperformance such as superior organic rental growth, lower capital expenditure on maintenance and favourable cap rate spreads. 

These social trends are also useful when examining the risks of the real estate sector. Technological innovation spells not just opportunity for the big warehouses, but also hints at potential disaster for UK retail. 

Last year, 43 multistore retailers ceased trading, affecting 2,600 stores and 46,000 jobs. Slowing footfall in UK high streets, linked in part to the rise and ease of shopping online, marks the retail sector out as high-risk, as does the poor performance of UK retail-focused REITs which lost an average of 3.5% per annum between July 2009 and July 2019, according to Bloomberg data. The GULP fund will have minimal exposure to retail at launch as a result of these troubling figures and sector headwinds.

Investors should remain wary of the risks associated with real estate and should opt for a trusted manager to sift the strong opportunities from the weak. The REIT regime continues to offer exciting entry into a specialist sector for investors, and with the issue of liquidity solved, property investments can prove a successful diversifier for a balanced portfolio. 

Matthew Norris, CFA, adviser to the VT Gravis UK Listed Property Fund

*10 year returns for FTSE EPRA NAREIT UK (31.07.09 – 31.07.19)

This article originally appeared on FT Adviser

Past performance is not a guide to future performance. The value of the investment and the income deriving from it can go down as well as up and can't be guaranteed. You may get back less than you invested.