TR Property Investment Trust : December 2022

The final month of a tortuous year for real estate equities provided a modicum of relief with a rally (on low volumes) in the last ten days of the year. This was largely macro-driven, with much stronger performances from the larger companies compared to the smaller names; investors saw interest-rate expectations soften on weaker economic data and less inflation in energy costs due to unseasonally warm weather.

The better performance in the last days of the year was a mere facade, with the sector being the worst overall performer in 2022 (EPRA Europe (-37.8%) versus Stoxx 600 (-10.6%)). Similarly, investment-grade real estate bonds (-18.2%) were the worst performer in the credit spectrum. The overwhelming driving force was the dramatic reversal of rates on the back of stubbornly high inflation.

With the Trust's focus on small and mid-sized businesses, it wasn't a surprise that the monthly net asset value (NAV) (+0.1%) fell behind the benchmark (+1.1%). In fact, December was the worst month of relative performance in 2022, driven by underperformance from such deep value UK micro caps such as Industrial REIT (-5.8%), Ediston (-7.9%) and Sirius (-10.2%). Swedish names, the most leveraged companies in our universe, continued their collective (but volatile) recovery from their October lows. We remain convinced that the overriding need to reduce the absolute amounts of debt that many of these names are carrying will result in weak performance. However, in the short term, there is plenty of room for rallies given the wide discounts to asset values.

UK physical property (as measured by MSCI/IPD) capital values were -5.5% in November, with 30 basis points (bps) yield expansion (after 36bps in October and 17bps in September). Industrial yields widened the most as investors recalibrated rental growth expectations. However, our expectation is that rental growth in industrial/logistics will remain positive given the fundamental supply/demand imbalance. With c.35% correction in the share prices of all of our industrial owners in 2022, we are confident that the current pricing (and discounts to corrected NAVs) is attractive.

The poorest call of the year was to maintain exposure to German residential, which remains a deeply unpopular market segment due to the huge amounts of bond refinancing required over the next two years. We chose to focus on the underlying income resilience (from regulated residential rents) and exposure to those businesses with little or no bond financing, such as Phoenix Spree Deutschland. However, all names in this sector have been hit hard, and it was scant reward that PSDL fell 'only' -36% while Vonovia fell -52%. Essentially, the lowest yielding asset class (residential) fared the worst as investors assessed the impact of refinancing at higher rates.

We continue to focus on businesses with lower amounts of near-term refinancing. Our base case is that rates will peak in 2023 but that central banks will have little latitude to adjust downwards, even in 2024. Real estate equity prices have adjusted to this new world but physical markets still need to find a new market equilibrium, which will only occur when sellers accept the new reality. Therefore, we expect that sizeable share price to NAV discounts will persist until property valuers catch up with the reality of the new cost of leverage. Indexation will continue to be a crucial support for the sector as income return will be a core element of total returns in 2023.

Discrete rolling annual performance as at 31.12.2022 (%):