A prudent approach to UK commercial property

Gerry Ferguson, Head of Wholesale and Property Fund Manager at Aberdeen Asset Management discusses the SWIP Property Trust and his outlook for the UK property market.

What is the objective of the fund?
The aim of the fund is to provide investors with a combination of income and growth of capital consistent with a balanced portfolio of UK commercial property. While we focus on income, because we believe that’s particularly important to investors at the present time, we also seek to deliver capital growth to help preserve wealth for investors.

Do you follow a specific strategy?
Yes, our strategy is one of managing a balanced portfolio of core and core plus properties. We have a very prudent approach, we look to minimise risk at all levels within the portfolio. We have a very robust analytical process when analysing acquisitions. This is because we believe it’s important that assets which we buy will give us, or give investors, long-term sustainable income.

Does the portfolio have a regional bias?
Within the portfolio, it’s all UK commercial property. We are invested across all the sectors – retail, office and industrial. The portfolio is very much focused on London and the South East, not surprisingly given where we are in the UK economic cycle.

How can investors differentiate this fund from other opportunities?
One of the most obvious characteristics of the fund is its size. It is currently over £2.6 billion in size and is one of the largest open ended funds in the UK (as at 31 March 2014).
There are a number of advantages with a fund of this size. One is the diversity of assets it can hold. We can invest into certain areas of the market inaccessible to smaller funds.
We can also carry out developments. I think we’re probably the only fund carrying out meaningful developments at the present time. These have been very successful to us, providing additional alpha returns to the fund.
Furthermore, the very fact the fund is large means that we have a significant presence in the UK property market. That has benefits in various areas such as seeing property that other managers don’t get to consider.

How do you manage liquidity in the portfolio?
Our approach is arguably unique in the world of open-ended property funds and should also be considered a key differentiator from other opportunities. Our ‘liquidity bucket’ is a blend of cash, property derivatives and bonds, property shares as well as real estate investment trusts (REITs). This combination is more correlated to property markets than simply holding cash and allows us to enhance the performance of our direct holdings while also helping to meet redemptions and managing flows.

Where are you seeing opportunities at present?
Opportunities are certainly broader than a few years ago. Good quality secondary stock has recovered well for example, but after rising to be the best-performing sub-sector in 2013 there is less obvious value to be found.
In our portfolio, we are running something of a barbell strategy, although potential for income growth is important across all our holdings and we feel this will be a major factor in the market over the next five years. At one end of the fund, we have prime assets in top locations, which continue to offer long-term leases and solid income growth but also have lower yields. At the other end, we own some high-yielding secondary properties; on these assets, we do not compromise on location but leases will tend to be shorter so there is more letting risk.

Do you see opportunities outside of office, retail and industrial sectors?
In these three mainstream sectors, we continue to see decent opportunities across the board, although retail remains more challenged as many of these businesses continue to reposition. We also have some concerns about rental growth prospects in this area, which will only subside when we see a genuine increase in consumer expenditure.
Elsewhere, we have benefitted from industrials by actively managing the income stream on some ‘just off prime’ assets. Within offices, we have largely focused on Greater London – and still see decent rental growth for the foreseeable future – but are starting to find more provincial opportunities. Beyond this trio, we like alternative areas and own some nursing homes and hotels, a private hospital and student accommodation. These properties give us diversification as they have different performance drivers, with student accommodation or healthcare not susceptible to the same economic pressures as more mainstream property.

Can you foresee any major risks to property?
Excessive short-term performance could prove a potential risk. Total returns this year might reach 15%, driven by the weight of money coming into the asset class, and we would view this as effectively stealing performance from 2015 and beyond. With the sector closely linked to on-going economic health, another bout of macroeconomic weakness is another obvious risk. That said we see property as something of a win-win at present. If we get better economic growth, bond yields will go up and rents will follow; yet if growth is slower than expected, yields stay lower and, in income terms, property will retain its attractive status versus bonds.

What is you broad macroeconomic view?
Overall, we expect the current slow and steady recovery to continue – companies are gradually becoming more optimistic about the future against this backdrop. We have focused on areas of the property market not suffering from oversupply, and with improving occupier demand expected we have positioned the fund with a slightly higher vacancy rate than usual to benefit from this. While comprising a modest part of the whole portfolio, we are also actively involved on the development side. We recently completed a project in Hammersmith, successfully converting a former car park into prime office space. We expect this property to be fully let in due course, with expressions of interest for 85% already, at rents higher than originally anticipated.

What is your outlook for the UK property market?
We are bullish, but perhaps more in the middle of the pack than some peers. We predict 10 to 12% returns for 2014, a 9% average over the next three years and a 5% average over the next five years. As long as the economic recovery continues, we expect strong performance from UK commercial property, which should outperform gilts and post respectable returns against equities.

Article appeared in the New Model adviser on 6th June 2014