UK Commercial Property REIT 26 August 2020

UK Commercial Property REIT (UKCM) is the largest generalist commercial property trust in the UK. Manager Will Fulton, of Aberdeen Standard Investments, has been progressively tilting the portfolio towards the industrials sector in recent years; which now makes up over 50% of the portfolio and has been more resilient to the impact of the pandemic.

This approach has helped portfolio performance to be reasonably resilient in the crisis, as we discuss under Performance. Will’s prudent reduction of gearing last year has also been beneficial, and UKCM has the lowest gearing of the generalist UK commercial property trusts. While the outlook for commercial property is cloudy, UKCM is on a relatively narrow discount of 20% compared to peers. We believe this is due to the low gearing and the sector positioning.

In April UKCM’s board exercised caution and reduced its dividend by 50%. On an annualised basis this dividend equates to a yield of 2.7%. However, as discussed in the Dividend section, the reduced payout has been very well covered by earnings, meaning we believe there could be scope for an increase – although we acknowledge the crisis has not passed.

Will’s strategy is to identify locations and properties benefiting from structural market changes, for example the continuing shift of retail spending from physical stores to online. The focus within industrials, therefore, is on the logistics and distribution sites used by online retailers and delivery services, plus multi-let industrial estates in and around London which are themselves often housing distribution activity. Another element to that approach is the attention paid to ESG considerations, both in terms of site selection and asset management.

The board took a prudent, conservative decision to halve the dividend when the outlook for the pandemic was unclear in April. However the reduced 0.46p quarterly dividend was 1.6 times covered by earnings in Q2, with dividend cover of 116% for the half year. We think there could be scope for the final dividend of 2020 to be increased; although we acknowledge retailers and alternatives in particular could have a troubled second half too, and rent collection is unlikely to be close to 100%. Consequently we think the 2.7% yield may underplay what investors are likely to get in the short to medium term.

Will has done a good job in attempting to future-proof the portfolio. But he could not ‘COVID-proof’ it, as the lockdowns were the ultimate black swan event for commercial property. Clearly his positioning away from high street and shopping centre retail and towards logistics has been helpful, and we think UKCM is well positioned for a slow return to normality.

Alternatives have been a drag in the short term, thanks to the lockdowns, but we think the pressure on retail property is likely to remain. Moreover the move to turnover-based rents would reduce the stability of income for which property investors invest. As a result, we think the broadened investment mandate should be beneficial from an income perspective in the medium term; while the core industrials exposure should display more resilient capital values through the cycle.