Disclaimer
This is a non-independent marketing communication commissioned by Schroder Investment Management. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.
Many aspects of our everyday lives involve commercial real estate. We may not always realise it but working, shopping, entertainment, leisure and living may all take place in commercially owned buildings. The industry is constantly changing, for example with the addition of new types such as giant logistic warehouses and data centres. Commercial real estate accounts for around a sixth of global greenhouse gas emissions so it is important that it is well managed and that owners decarbonise buildings and adapt them to climate change. Given that real estate is a physical asset, it behaves differently from other financial assets and interest in it as an investment opportunity is growing. Real estate is undergoing a period of democratisation, with investors of all types looking to understand the value it can bring to a diversified portfolio.
Closed-ended investment trusts represent one of the most attractive ways that investors can access real estate because, as a permanent source of pooled capital, they bring liquidity to an illiquid asset class. Here we explore some of the advantages that real estate investments can bring to a diverse portfolio, with a look at the two Schroders investment trusts that specialise in the asset class.
Risk and return
In the traditional terms of risk-return profile, real estate typically sits between fixed income and equities. It generally has a higher risk-return profile than bonds, and a lower risk-return profile than the majority of equities. When managed effectively, however, real estate can offer attractive elements of both.
Returns on equities tend to be largely driven by share prices rising and falling (capital appreciation and depreciation), particularly in the short-term. Fixed income returns tend to be dominated by coupon payments (income).
As a real asset, operational excellence and a hospitality mindset are crucial to driving sustainable income and value creation – every building is managed as its own business, focused on optimising tenant services and performance through efficiently run operations to minimise cost and waste of resources.
Inflation-linked performance
The income from commercial real estate can provide investors with some protection against high inflation, like that which we are currently experiencing. Rents in the EU are generally indexed to inflation and while there is no explicit link in most UK leases, commercial rents in the UK have kept pace with inflation over the long term. That said, it should be noted that commercial real estate values and returns are also influenced by interest rates and that a rise in interest rates at a time when the outlook for the economy is deteriorating could lead to a fall in values, even if rents are rising.
Diversification benefits
Historically, returns from global real estate and fixed income have had a negative correlation relationship. This means that, when the return from one of those asset classes goes up, the other goes down, and vice versa.
There has been a generally low positive correlation between global real estate and equities, which means they tend to move in broadly the same direction over time. Nevertheless, real estate’s low correlation to other asset classes suggests that including it in a multi-asset portfolio can improve overall levels of diversification.
Indeed, the data below demonstrates that, over the past ten years, including a 20% allocation to global real estate in a 60:40 portfolio of global equities and global bonds, modestly increases overall returns and meaningfully decreases annualised volatility.
Adding real estate to a diversified portfolio can improve outcomes
Source: ANREV / INREV / NCREIF, Burgiss, Datastream, Federal Reserve Bank of St Louis, Schroders Capital, August 2022. Data shows returns and volatility over 10 years to Q1 2022, with global private real estate represented by an 80% core, 20% value add allocation
Experience is key
As with all private investments, performance is subject to investor expertise. Experience is absolutely vital, as is proximity to the underlying assets both geographically and operationally. Fortunately for investors, Schroders Capital has been directly investing in real estate for more than 50 years and has a specialist team of more than 160 professionals across 13 offices. It has two investment trust options which offer all these characteristics in combination.
Schroder Real Estate Investment Trust - SREI
Launched in 2004, the Schroder Real Estate Investment Trust seeks an attractive income with capital growth potential from a portfolio of UK commercial real estate. Managed by Nick Montgomery and Bradley Biggins, the Company’s strategy is to own and actively manage a diversified portfolio of properties located in the UK’s “winning cities”, which benefit from higher economic growth than the country as a whole.
Nick and Bradley are supported by a diverse and highly experienced team of investment specialists, which facilitates a deep understanding and coverage of all commercial real estate sectors across the UK with on-the-ground resources. The team has developed a data-led ESG framework, with a focus on driving demonstrable improvements to the sustainability profile of portfolio assets.
Currently, the Company invests in 42 properties with a total value of £532m1, focused on multi-let industrial estates, retail warehousing and offices in winning cities such as London, Manchester and Edinburgh. The shares yield an appealing 7% and the team’s dynamic approach to portfolio allocation and active asset management provide the means to generate a sustainable rising income, as well as capital growth across market cycles. Recent transactions and asset management mean that SREI is the only company in its immediate recognised peer group to be paying a dividend above its pre-pandemic level.
With high inflation and rising interest rates as a backdrop, the outlook for the UK economy is somewhat challenging at the moment, and the team is realistic about the prospect of capital growth in the near term, with a decline expected over the next eighteen months. Nevertheless, shares in the Schroder Real Estate Investment Trust currently sit at a near 40% discount to its net asset value. This suggests that more than enough bad news on capital values could already be in the price. Furthermore, SREI is well positioned for a more uncertain environment with the lowest cost, longest duration debt in its peer group.
Schroder European Real Estate Investment Trust - SERE
The Schroder European Real Estate Investment Trust was launched in 2015, to provide a long-term sustainable income and value from growing European cities. The Company is managed by Jeff O’Dwyer, who is supported by a large team of multi-sector real estate professionals, located in key hubs across Europe.
Like, its older UK-focused brother, the trust targets Europe’s “winning cities”, such as Paris, Berlin, Hamburg and Stuttgart. These locations offer a competitive advantage with higher levels of GDP, employment and population growth, differentiated local economies with higher-value industries and well-developed infrastructure networks. Ultimately, these cities represent places where people want to live and work, which should underpin long-term growth in both income and property values. Specific sub-markets targeted are those that will benefit from transport infrastructure improvements, supply constraints, competing demands for uses and assets that are leased off affordable and sustainable rents.
The Company’s real estate portfolio is currently valued at €218.7m, with approximately €50m of additional capital to deploy. Some of this fire power stems from our ability to refurbish, and exit office properties. The team can has excellent credentials in this space, particularly their active asset management expertise and ability to create value by improving an asset’s sustainability credentials. The Company expects to see an improving pipeline of investment opportunities over the next twelve months that will enable it todiversify and strengthen its portfolio further.
In the meantime, the high quality portfolio looks capable of delivering a reliable income stream (with a current yield of 8.3%) alongside potential for long-term income and capital growth. All of the portfolio’s rental income is subject to indexation (80% annual), which should provide good levels of inflation linked rental income for investors. The Company uses modest leverage with a current loan-to-value ratio (LTV) of c.30% and a maximum capacity of 35%.
Conclusion
Real estate can offer an attractive balance of risk and returns for investors of all types. Historic data demonstrates that including a modest allocation to real estate within a diversified global portfolio can result in higher returns and lower risk. This may be particularly attractive in the current environment because real assets can also offer investors real protect against inflation.
Schroders has more than 50 years’ experience investing directly in global real estate. With its scale, on the ground resources and focus on high growth “winning cities”, its two real estate investment trusts offer private investors an excellent way into this attractive asset class.
1 - Source: Schroders, 30 September 2022
Schroder Real Estate Investment Trust - Risk Considerations:
Investments in real estate are relatively illiquid and more difficult to realise than equities or bonds. Yields may vary and are not guaranteed. The use of gearing is likely to lead to volatility in the Net Asset Value (‘NAV’) meaning that a relatively small movement either down or up in the value of the Company’s total assets will result in a magnified movement in the same direction of that NAV.
There is no guarantee that the market price of shares in Investment Companies such as SREIT will fully reflect their underlying NAV. The value of real estate is a matter of a valuer’s opinion rather than fact.
The trust may be concentrated in a limited number of geographic regions, industry sectors, markets and/or individual positions. This may result in large changes in the value of the fund, both up or down, which may adversely impact the performance of the funds.
The Company may borrow money to invest in further investments, this is known as gearing. Gearing will increase returns if the value of the assets purchased increase in value by more than the cost of borrowing, or reduce returns if they fail to do so.
Schroder European Real Estate Investment Trust - Risk Considerations:
Investments in real estate are relatively illiquid and more difficult to realise than equities or bonds. Yields may vary and are not guaranteed. The use of gearing is likely to lead to volatility in the performance of the Net Asset Value (‘NAV’) meaning that a relatively small movement either down or up in the value of the Company’s total assets will result in a magnified movement in the same direction of that NAV. There is no guarantee that the market price of shares in Investment Companies such as SEREIT will fully reflect their underlying NAV. The value of real estate is a matter of a valuer’s opinion rather than fact.
The trust may be concentrated in a limited number of geographic regions, industry sectors, markets and/or individual positions. This may result in large changes in the value of the fund, both up or down, which may adversely impact performance of the funds.
The Company may borrow money to invest in further investments, this is known as gearing. Gearing will increase returns if the value of the assets purchased increase in value by more than the cost of borrowing, or reduce returns if they fail to do so.
The trust can be exposed to different currencies. Changes in foreign exchange rates could create losses.
Important Information
This information is a marketing communication.
This document does not constitute an offer to anyone, or a solicitation by anyone, to subscribe for shares of Schroder Real Estate Investment Trust (the “Company”). Nothing in this document should be construed as advice and is therefore not a recommendation to buy or sell shares.
Any reference to sectors/countries/stocks/securities are for illustrative purposes only and not a recommendation to buy or sell any financial instrument/securities or adopt any investment strategy. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on any views or information in the material when taking individual investment and/or strategic decisions.
Past Performance is not a guide to future performance and may not be repeated.
The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Exchange rate changes may cause the value of investments to fall as well as rise. Schroder Real Estate Investment Trust have expressed their own views and opinions in this document and these may change. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy.
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Issued in December 2022 by Schroder Unit Trusts Limited, 1 London Wall Place, London EC2Y 5AU.
Registration No 4191730 England. Authorised and regulated by the Financial Conduct Authority
