BMO Real Estate Investments 16 October 2019

BMO Real Estate Investments (BREI) is a Real Estate Investment Trust (REIT) which aims to generate an attractive income from a portfolio of commercial property assets selected for their quality characteristics and income-generating potential.

One of the key attractions is the yield on the portfolio which has enabled a 5p per share dividend to be maintained over the past five years. On the current share price this represents a yield of 5.9%. The NAV yield of 5.3% compares to 4.4% on the MSCI Quarterly Property Index. BREI is a broadly sourced trust, with all sectors of the portfolio generating a higher income than those in the benchmark. The manager, Peter Lowe, aims to pay a high yield without sacrificing income growth, yet still being mindful of the need to protect capital. Over the year to June 2019, like-for-like income on the portfolio has grown by 4.4% compared to 2.2% for the index.

The trust’s outperformance of the index and sector over five years has been largely driven by a superior income return. The trust has net gearing of 26.5%, with £90m of structural gearing maturing in 2026 (roughly 35% of NAV) offset by holdings in cash. This gearing has helped the trust outperform in rising markets but also increases its sensitivity to falling markets.

Since taking over in 2016, the manager Peter Lowe has shifted the portfolio to be overweight industrials and reduced exposure to retail, avoiding more troubled sectors such as shopping centres and department stores. Peter has also concentrated the portfolio further in the South East of England. He focuses on locations with alternative uses and strong economic fundamentals, which should support value in a property past the end of its current tenancy, as well as aiding resilience in a downturn. Beyond location, the quality emphasis comes through in an exceptionally low void rate (currently 0.1%), low levels of over-rent, and high exposure to tenants in less cyclical and more defensive industries.

The trust discount has widened significantly in recent months as concerns over Brexit have resulted in poor market sentiment towards UK commercial property. The managers believe that BREI is not overly exposed to a hard Brexit outcome, given the quality and defensive characteristics of the portfolio. The shares now trade on a discount of 19.5%, having been at a premium as recently as 2018; this followed the rebound which occurred after the 2016 referendum sell-off.

Taking a medium-term view, BREI looks attractive on its current wide discount, although concerns about a no-deal Brexit could see sentiment remain poor in the short term. While the outlook for the property sector on a NAV basis is not particularly attractive – this is clearly a late-cycle environment – a near 20% discount seems unwarranted.

Aside from Brexit, the other cloud over the sector is retail. While we believe there are further falls in value to come in retail, the trust’s 34.6% allocation would have to be written down by 58% to justify the current discount, which is clearly excessive (assuming flat values elsewhere). Even if we apply an across-the-board discount to UK commercial property of 10%, to account for the potential impact of Brexit on values, we would have to write the retail property down by 39% to get to the current discount. Furthermore, even if a recessionary environment should take hold, there is scope for a yield of 5% or more from this portfolio, given the manager’s record of generating income growth and the quality assets in the portfolio. However, the trust’s £90m of gearing, maturing in 2026, would increase its sensitivity to a falling market.