In the context of COP26, the focus has been on sustainability issues in recent months. It’s not going to go away: A series of initiatives have been launched to encourage and hold financial institutions and businesses to account on how they will go net zero carbon.
The investment company sector includes companies at the forefront of switching to renewable energy, improving energy efficiency, tackling social issues and promoting good governance. Some fund managers have been very creative in how they have incorporated these issues into their approach to investing.
This week let’s see what Jason Baggaley has been up to Standard Life Investments Real Estate Income Trust (SLI).
With a market value of just under £ 300million, SLI sits roughly in the middle of the Association of Investment Companies’ UK commercial real estate sector.
By the way, I strongly believe that these investment firms should be much larger in absorbing the open real estate funds of the managers. It is obvious to almost everyone that open structures are totally inappropriate for illiquid assets like real estate.
For reasons I do not understand, the Financial Conduct Authority consistently chooses to increase the complexity of these open structures rather than promoting the simple solution of forcing them to become real estate investment trusts.
SLI shares trade at a discount of 19% below the net asset value (NAV), which in my opinion is too broad and unwarranted. It was trading at a premium before the Covid-19 panic in early 2020. The impact this had on rent collection and the dividend, and the feeling that the pandemic would have permanent effects on the real estate market, were good reasons for a discount to emerge. .
However, having recovered its NAV above its pre-Covid level, I would have thought the nerves would have calmed down enough for the gap to close.
The value of the trust’s assets grew by more than 10% in the first six months of the year and increased another 5.4% from the third quarter of 2021, outperforming its benchmark MSCI.
It is true that, as new measures are introduced in Europe in response to the increase in cases, we cannot be sure that the Covid-related lockdowns are behind us. It could mean more months of pain for the real estate industry.
Another cloud hanging over commercial real estate is the prospect of higher interest rates in response to rising inflation. However, we are a long way from the types of interest rates that would have a big impact on the industry.
Change in use of property
Covid-19 has accelerated the decline of retail and department stores while boosting demand for warehouse space, benefiting funds such as Large Tritax Box (BBOX) and Urban logistics (COTTAGE). It called into question the attractiveness of downtown offices and caused serious cash flow problems for leisure businesses. Navigating the events of the past year and predicting the shape of the future housing market has been tricky.
Part of Baggaley’s response has been to focus on sustainability and improve the quality of SLI’s portfolio. He believes tenants will become increasingly picky about the environmental qualities of the spaces they occupy and may be willing to pay more for better buildings.
They are also likely to favor buildings with facilities such as showers and bicycle racks and even nurseries and cafes. Baggaley says investors in older, less user-friendly buildings will soon start to worry about renovation costs (especially since these are hit by inflation).
In our own business, we think about things like how we can do our part to reduce electricity use and our heating bill. Moving to a more energy efficient office would make us a much greener operation all of a sudden.
We also mix office work with working from home – a model adopted by many other businesses. The effect has been low use of space in cities like London and increasing availability.
The impact will be felt more strongly on inferior and rigid offices, which will be much more difficult to re-let without lowering rents. Baggaley took preventative action and sold assets such as an office in Farnborough leased to BAE. He was prepared to take a small cut on the appraisals of these properties.
New purchases include retail warehouses and logistics assets, which are adapted to the changing retail landscape.
Cairngorms National Park in North East Scotland, which will see 1.5 million trees planted as part of a Standard Life Investments Property Income Trust investment
The unusual investment, however, was the acquisition of 1,447 hectares of wild pasture and open moorland in Cairngorms National Park for £ 7.5million. He plans to plant 1.5 million trees on the site, funded by grants, which are expected to offset around 195,630 tonnes of carbon through 2060.
Baggaley believes the move puts SLI ahead of the pack in this area and will be viewed as positive by tenants as well as environmentally conscious investors. He predicts that the value of the associated carbon credits will increase over the next several years as others seek ways to meet net zero emission promises. I think he’s probably right on this point.
I also think Baggaley has a good idea of where the UK property market is heading. At the end of June, more than half of the portfolio was in the industrial sector in demand; 29% were in offices, including 6% in central London; retail warehouses accounted for 10%; and street-level retail was only 2% (the missing 10% is “other”).
We could see the portfolio evolve further over the next few months. Indeed, this morning the company announced the completion of two new leases and two rent revisions that will add nearly £ 700,000 in annual rent, while a lawsuit to collect arrears from its biggest non- rent-payer brings in an additional £ 625,850. So far this year 92% of rents have been collected.
James Carthew is a director of Marten & Co. The opinions expressed in this article are his own and do not constitute investment advice.