BMO Real Estate Investments (BREI) sits on one of the widest discounts in the AIC UK Commercial Property sector despite a clear recovery in performance over the past year, rent collection of 97% during the crisis (see Dividend) and a portfolio over 50% invested in the outperforming industrials sector. The discount narrowed significantly towards the end of 2020, but while the NAV has risen in 2021, the rating has lagged and the current 23.3% looks like a potential opportunity.
The board paid a higher quarterly dividend in September following strong rent collection and an improving outlook for the property market. The current 1p a share is expected to be maintained and represents 80% of the pre-pandemic level. As we discuss in Dividend, annualising the new dividend level gives a prospective share price yield of 4.7%.
BREI’s manager, Peter Lowe, took over in 2016 when the portfolio had significant holdings in retail, but the current iteration of the portfolio is very different from what he inherited. The portfolio is 50.6% invested in industrials (as of 30/09/2021) and has a further 18.3% in retail warehouses, the consensus winning sub-sector within retail, with just 6.5% in standard retail. Peter recently added to the existing industrial and retail warehousing exposure, completing purchases in both sub-sectors, and is looking to add to them further, as we discuss in Portfolio.
The pandemic was a difficult period for the property sector, but BREI’s property portfolio is now greater than its pre-pandemic valuation. The trust has outperformed its generalist UK commercial property peers over recent years in NAV total return terms, including over 2020, as we discuss in Performance.
There is no good reason for BREI to trade on such a wide discount in our view. We highlighted the discount as an opportunity last June, following which the shares rallied by almost 30% in six months, and the Discount narrowed significantly. We think the relative valuation opportunity is as good as it was then, although market conditions have changed. It may be the market has been slow to digest the significance of the raised dividend which means the trust yields 4.7% with full dividend cover.
We also think it worth highlighting BREI’s strong performance versus its generalist peers. The portfolio performed relatively well in 2020, which is testament to the manager’s strategy and stock selection decisions.
In the short term, it may take a recovery in economic sentiment for the shares to rally significantly once more, and we note risk aversion has seemed to be higher in recent months across markets which may have led to BREI’s discount drifting. However, property has attractions in an inflationary environment – and fears of the latter seem to be causing the current wobble. In theory, rents should be able to hold up, either through agreed inflation-linkage or through periodic re-leasing. Meanwhile, many rising operating costs are paid by the tenants (although that is increasingly less the case in the competitive office sector). While a weakening economy would negatively affect tenants, real assets such as property should offer protection in an inflationary environment.
|Offers a high yield with more than comfortable cover
||The small size of the trust could increase discount volatility relative to peers
|Strong bias to industrials, which is well supported by secular trends
||The levels of gearing increase the volatility of NAV
|Commitment to high ESG standards has been validated with rising scores from external bodies
||The economic sensitivity of property could work against it in a full-blown recession