TR Property Investment Trust a punishing end to the year

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TR Property Investment Trust plc (LON:TRY), announced today its full year results for the year ended 31 March 2020 (unaudited).

Financial Highlights and Performance	Year ended 31 March2020 (unaudited)	Year ended 31 March2019	%Change
Balance Sheet	358.11p	418.54p	-14.4%
Net asset value per share
Shareholders’ funds (£’000)	1,136,453	1,328,254	-14.4%
Shares in issue at the end of the year (m)	317.4	317.4	+0.0%
Net debt^1,6	7.6%	10.0%

Share Price
Share price	317.50p	394.00p	-19.4%
Market capitalisation	£1,008m	£1,250m	-19.4%

	Year ended 31 March 2020 (unaudited)	Year ended 31 March 2019	%Change
Revenue	14.62p	14.58p	+0.3%
Revenue earnings per share

Dividends²
Interim dividend per share	5.20p	4.90p	+6.1%
Final dividend per share	8.80p	8.60p	+2.3%
Total dividend per share	14.00p	13.50p	+3.7%

Performance: Assets and Benchmark
Net Asset Value total return ^3,6	-11.5%	+9.1%
Benchmark total return⁶	-14.0%	+5.6%
Share price total return^4,6	-16.8%	+6.2%

Ongoing Charges (%)^5,6
Including performance fee	+0.80%	+1.10%
Excluding performance fee	+0.61%	+0.63%
Excluding performance fee and direct property costs	+0.59%	+0.61%

1. Net debt is the total value of loan notes, loans (including notional exposure to CFDs and Total Return Swap) less cash as a proportion of net asset value.

2. Dividends per share are the dividends in respect of the ﬁnancial year ended 31 March 2020. An interim dividend of 5.20p was paid in January 2020. A ﬁnal dividend of 8.80p (2019: 8.60p) will be paid on 4 August 2020 to shareholders on the register on 19 June 2020.

The shares will be quoted ex-dividend on 18 June 2020.

3. The NAV Total Return for the year is calculated by reinvesting the dividends in the assets of the Company from the relevant ex-dividend date. Dividends are deemed to be reinvested on the ex-dividend date as this is the protocol used by the Company’s benchmark and other indices.

4. The Share Price Total Return is calculated by reinvesting the dividends in the shares of the Company from the relevant ex-dividend date.

5. Ongoing Charges are calculated in accordance with the AIC methodology. The Ongoing Charges ratios provided in the Company’s Key Information Document are calculated in line with the PRIIPs regulation which is different to the AIC methodology.

6. Considered to be an Alternative Performance Measure as deﬁned in the full report and accounts.

Chairman’s Statement

Introduction

It was a punishing end to the year for the market and TR Property was no exception. For the year ended 31 March 2020, the Trust delivered a Net Asset Value (NAV) total return of -11.5% which although disappointing was ahead of the benchmark total return of -14.0%. The share price total return was lower at -16.8% as although the Trust’s shares traded close to, and often at a premium to the Net Asset Value for a large part of the year, the discount widened as the sell-off in global equities began in mid-February. The share price ended the ﬁnancial year at a discount to the Net Asset Value of 11.3%.

Rarely has any 12 month reporting period been so dominated by the events of the last six weeks of the ﬁnancial year which moved the performance so considerably. For the ﬁrst ten months of the year, pan European real estate equities were enjoying a benign economic backdrop. Although the outlook for global (and European) growth had been slowing in 2019, central banks around the world were determined to offer support through further easing of monetary policy. This beneﬁted income focused assets such as property. The autumn was dominated by the reversal of the previously negative sentiment towards the UK with strong performance from domestic focused businesses including many property companies. This gained further momentum following the large Conservative majority at the General Election in December. As the new year got under way, earnings from companies we were invested in continued to show steady growth and, outside of the retail sector (which continued to experience structural headwinds), management teams remained conﬁdent of the return prospects for their businesses. As a result, up until mid-February performance was strongly positive.

However, the unprecedented impact of COVID-19 has swept aside much of the relevance of previous market conditions, for the time being. The enormous state support provided by governments and central banks is of course crucial but the pace and scale of the recovery in demand will dictate which parts of the property sector rebound and to what extent. The crisis has reinforced many long running convictions particularly around the further degrading of retail property rents, the growth of logistics and the stability of income from rented residential assets.

This crisis, like many others which markets have endured, reinforces the importance of liquidity and solvency. It is worth reciting that TR Property was established in 1905 and, as an Investment Trust, is a closed ended company meaning that its capital is permanent. This long-term conﬁdence means the Trust can invest in illiquid assets such as direct property and smaller companies, in the knowledge that we will not be subject to a call for capital from investors as might happen with an open-ended equivalent.

Our closed-ended structure means we can concentrate entirely on the portfolio construction without concerns about redemptions. In turbulent markets investors will allocate a premium for liquidity, and this can lead to investment opportunities, particularly amongst temporarily unloved smaller companies. The Trust has a strong track record of patiently building positions in good quality smaller companies and our experience is that these businesses either grow, merge or get taken private if the public markets persistently undervalue them. The Manager’s report which follows, provides some examples of these types of successes this year. The Trust’s structure also enables us to own physical property and again over the years this has added value as well as providing our team with direct market intelligence. This year our physical portfolio was a strong contributor to performance following several asset management successes. Therefore, these illiquid investments have often proved to be accretive to performance over time.

The longevity of permanent capital combined with an independent Board of directors whose responsibility and clear priority is to stakeholders, provides the foundation on which we are able to get the best from the manager. On the one hand, the manager is in no doubt that they are appointed, monitored and will be challenged as necessary, by the Board. On the other hand, the long-term nature of the Trust instils in the Manager a very strong commitment to the success of the Company. Long-term investors and especially those who have heard them speak will be in no doubt about the strength of that commitment.

Looking back over the last decade, the Trust has delivered a share price total return of 171% and a NAV total return of 157% versus a benchmark ﬁgure of 97%. This performance compares well to the FTSE All Share total return of 53% and the STOXX Europe (in EUR) total return of 72%. Income remains a crucial element of property’s total return and our dividend payments over the same 10 year period (and including the ﬁnal dividend announced today) have recorded a compounded annual growth rate of 9.3%.

Revenue Results and Dividend

Revenue earnings of 14.62p per share were marginally ahead of the prior year earnings of 14.58p. Although the interim earnings were 7.7% ahead of the prior year’s interim earnings, changes to the portfolio in the second half of the period, together with some dividend suspensions very close to the year end resulted in lower second half income.

The Board has announced a ﬁnal dividend of 8.80p bringing full year dividend to 14.00p an overall increase of 3.7% over the prior year dividend.

Revenue Outlook

A number of companies we invest in have announced dividend suspensions or cuts and others may follow. Therefore, we predict a fall in earnings for the next ﬁnancial year. As detailed in the Manager’s Report, the portfolio continues to seek income resilience wherever possible.

One of the advantages of the Investment Trust structure is that the Board is able to look at the underlying sustainable level of dividend and adjust the pay-out level accordingly. The Board has been consistently cautious with pay-out levels in recent years as often there have been one-off factors boosting income. The Company has a healthy level of revenue reserves which have been accumulated over time to provide resilience in the event of a crisis. These will be used to supplement short to medium term falls in earnings until such a time as conditions settle and the Board can determine the long-term income capability of the portfolio.

Net Debt and Currencies

We have added to the borrowing capacity of the Company during the ﬁnancial year. A new facility widened our banking relationships, and an existing facility increased on renewal. These are all revolving annual facilities and provide ﬂexibility to complement the longer-term private placement ﬁxed term debt that we have in place.

The overall level of gearing began the year at 10.0% and closed at 7.6%. Over the year, gearing levels have ﬂuctuated as market conditions and outlook have changed from a high of 14.5% in early December 2019 to a low of 5.2% in mid March 2020. With the year end gearing at 7.6% and UK investment property exposure of 7.8%, the Trust was marginally underweight equities against the benchmark.

Sterling ended the year around 3.5% weaker versus the Euro than at the beginning but traded through a 10% range. The average value of Sterling versus the Euro over the year was around 1% stronger than through the previous year. This had a small negative impact on earnings. Our currency strategy remains unchanged in that capital exposure is hedged to match that of the benchmark, but the income remains unhedged.

Discount and Share Repurchases

The discount of the share price to the Net Asset Value averaged just under 2%. However, for a large part of the year the share price stood close to or at a premium to the Net Asset Value. In common with the Investment Trust sector as a whole, the share price falls in late February and early March were ahead of the falls in the asset value and the discount widened sharply, ending the year at 11.3%.

There were no share repurchases in the year.

Board Changes

I have previously announced my intention to stand down from the Board at the forthcoming AGM, having served for a requisite period. I am succeeded as Chairman by David Watson who, as well as being extremely experienced and capable, has a thorough understanding of the Trust having been a director for over 8 years during which time he has served as Senior Independent Director and, until last year, as Chairman of the Audit Committee. I am also very grateful to Simon Marrison who continues to bring his considerable knowledge of the European property markets and will become the Senior Independent Director.

I have been particularly delighted to welcome two new appointments to the Board over the past year. As I mentioned in the Interim Report, Kate Bolsover joined the Board in October bringing a wealth of experience in Investment Trusts and at Board level. More recently, in January, I announced that Sarah-Jane Curtis had also joined bringing extensive experience in the London property sector, and particularly in retail.

These changes will help to ensure that this strong Board maintains a healthy balance of commercial experience, property and broader market skills, knowledge and expertise combined with fresh and independent thought.

Outlook

As we all know, the COVID-19 virus exacerbated by the collapse in oil prices, has disrupted ﬁnancial markets and undermined global economic growth prospects.

The period of the pandemic and whether it will re-escalate once containment measures are relaxed, is unpredictable. Therefore, it is very difﬁcult to gauge the extent of the impact as the timing of this document coincides with the ﬁrst tentative steps in the relaxation of the lockdown across much of Europe.

One of the strong characteristics of property as an investment has been its healthy income prospects. It is clear that rent receipts in the immediate future will be severely disrupted across many of the companies we are able to invest in and this will vary widely with consumption focused properties likely to face disruption for longer. However, it is pleasing to report high rates of rent collection from healthcare, logistics and rented residential; all sectors we favour.

There will be an increased polarisation between sectors; the acceleration of the structural decline of retail is an example of this. Those assets able to produce good quality income streams with potential for growth are likely to be deﬁned more narrowly and be in greater demand. Consequently, the level of divergence between those businesses with growth prospects and those without has widened enormously due to the pandemic.

The low costs of borrowing and skinny yields on ﬁxed income will remain a feature of the ﬁnancial landscape, increasing the value of income particularly where it is index-linked. This will support the attractiveness of property as an asset class although not necessarily protect it against market ﬂuctuations caused by macro events that move global equity markets, such as that which we have witnessed in the closing weeks of this ﬁnancial year.

The delivery of performance in this environment requires a meticulous and rigorous approach to evaluating investment opportunities and this plays to the strengths of the strategic approach of the Trust and of the manager. TR Property has a long and successful track record of delivering solid performance by investing in strong management teams, in well-funded businesses with strong cash ﬂows and the potential for earnings growth. We will maintain this approach combined with the mitigation of risk through a diverse portfolio invested across numerous submarkets and geographies.

Finally, I leave the Board with a strong sense of pride that TR Property is in extremely good hands with an impressive and eminently capable Board overseeing a manager with immense experience and a strong track record.

Hugh Seaborn

Chairman

28 May 2020

Manager’s Report

Performance

The Net Asset Value total return for the year was -11.5%, the benchmark total return was a little poorer at -14.0%. Disappointingly, the share price total return was -16.8% as the discount to the net asset value widened in the period. Reviewing the performance of the Trust two months after the March year end always feels a little like appraising historical and sometimes outdated events. This time I can make that statement with absolute conviction. The ﬁrst ten months of the ﬁnancial year bear little resemblance to either of the last two (February and March) or indeed what has transpired even more recently.

The ﬁgures speak for themselves. From 31st March 2019 to 19th February 2020, the NAV rose +21.4%, the benchmark +17.1% and the share price total return reached +30.0% as the stock touched a record premium to asset value of 5%. February saw the peak and the beginning of the market correction which accelerated dramatically later in the month and on into March. The 20th February to 31st March 2020 performance was -27.2% for the NAV, -26.5% for the benchmark and -36.2% for the share price. The shares bore the additional impact moving from a 5% premium to a 11.3% discount.

Looking back, the steady march upwards in the asset value and the share price through 2019 reﬂected the dual drivers of sound property market fundamentals (in our preferred markets) coupled with, in the second half of the period, the positive effect of the removal of a crucial amount of Brexit uncertainty. Whether one was in favour of that outcome or not was not the issue; markets prefer certainty and aided by the landslide Conservative majority the UK (where we were overweight) performed strongly. The collective outperformance of the UK’s listed property companies versus their Continental European cousins is a feature of the market we haven’t seen for several years.

We entered the new year with some optimism that low inﬂation (and low rates) would underpin the hunt for income and support real estate values. In our preferred markets of logistics/industrial, ofﬁces in key major cities, rented residential and alternatives such as student accommodation and healthcare we saw steady demand and (in most cases) a lack of speculative supply leading to rising rental levels. This ambient environment was exemplified by the collective performance of the Swedish cohort of listed real estate companies. This group have traditionally operated not only with higher levels of gearing than the rest of the sector but also almost always focused on short term (and cheaper) ﬁnance. When future debt costs look stable (or falling) and the domestic economy is humming along these stocks do well. In 2019, they collectively returned 52.6% (in SEK). The proverbial canary was quite perky on its perch.

As highlighted in the Interim Report, I remain focused on those subsectors which I felt would continue to beneﬁt from these fundamental market conditions. This meant that I stayed away from UK retail and increasingly that applied to European shopping centre landlords as well. I have in the past highlighted that the decline in the values of UK retail property companies was on a faster trajectory than their European counterparts given the higher rate of online penetration, less affordable rents, higher property taxes and broad management ineptitude (principally too much leverage). Over the year, I have grown increasingly pessimistic for this asset class in all markets. Our underweight to both UK and European retail helped relative performance.

The one corner of the retail landscape to which these macro factors are far less applicable remains food. The UK is dominated by a small group of national operators. The existing store network is crucial to their online businesses. Even before the current crisis we liked the long income, covenant quality and operational necessity of key stores. Supermarket Income Reit (1.8% of assets) returned +13.4% in the year.

Whilst the exposure to our preferred sectors generally aided relative performance I, once again, suffered from our underweight to the two traditionally defensive regions namely Switzerland and Belgium. Stocks in both markets screen poorly on relative fundamental value but Swiss property companies had a very strong year, driven (we think), by the seemingly perpetual negative rate environment in Switzerland. Any stock yielding 3% seems to be a buy regardless of fundamentals. I shouldn’t have been such a purist. However, they also perform well when investors are nervous and having outperformed in the ﬁrst 9 months of the ﬁnancial year they also did relatively well in February and March.

Once again the strongest performance came not only from our overweights to the best performing sectors but from key stocks within those sectors. The best example is Argan (4.1% of assets), the French logistics owner/developer. During the year the company acquired a portfolio of big box logistics units let to Carrefour increasing the portfolio size by 40% to 2.8m sq metres. The stock’s total return was a top performing +19.7% over the period.

The portfolio has some gearing although this was heavily reduced in late February and March. In a period of negative returns it is important to explain the rationale for having any at all. The Trust has often taken advantage of its closed ended structure and held a number of illiquid small cap stocks. These well run companies exposed to outperforming subsectors often suffered from investor oversight being deemed too small. As a consequence, in rising markets they often underperform their larger brethren (in market parlance their ‘beta’ is less than 1). Adding some gearing helps compensate for these lower beta names. Our experience is that over time the underlying property fundamentals would be recognised and, if not, then the market would take them private or merge them together. In the last 18 months we have seen the privatisation of Green REIT (Ireland) and Terreis (France) alongside the merger of AJ Mucklow with LondonMetric. All of these situations added value to the portfolio as has our physical property portfolio (7.8% of assets) and this exposure also sits outside of our benchmark.

Offices

The resilience of the London ofﬁce market in terms of both rents and capital values in 2019 surprised us. Our concerns that the Brexit ‘drag’ would defer decision-making appears to have had only a marginal impact. The key feature of the market has been the strong performance of new and Grade A space as companies continue to focus on the best quality environment for their workforce. The strongest forward looking indicator was that 60% of all space under construction and due to complete by the end of 2023 (12.5m sq ft) was under offer or pre-let. The impact of COVID 19 will be a deferral of both physical completions and potential starts coupled with reduced demand due to fewer job creations. The ﬁrst impact (reduced/deferred supply) is a positive and the second clearly a negative. The unknown is the scale of reduced demand. We expect the ﬂexible ofﬁce suppliers to bear the brunt of this short term impact. According to CBRE estimates, if 25% of all ﬂex space was returned to the market vacancy would rise to 6% overall. For context the 20 year average vacancy for Central London is 5%. Prime rents are currently £110 per ft in the West End and £73 per ft in the City with rent frees of c.20-24 months for a 10 year term certain. Incentives will rise and rents will come under pressure in the near term. However capital values may not fall signiﬁcantly as London’s prime ofﬁce yields didn’t tighten over 2019 as investors still priced in Brexit uncertainty. As a result it looks cheaper than many of the European alternatives.

Across Europe, 2019 was another busy year for many ofﬁce markets with occupier momentum maintained even in the face of a broader economic slowdown. There were numerous instances of markets beating pre-GFC rent peaks – Brussels, Berlin, Milan, Barcelona and Lyon to name a few. Ofﬁce vacancy across Europe reached a record low of 5.8% (according to BNP Paribas). This positive occupation momentum also drove investor demand with yields tightening by 26bps to an average of 4.2% for the 40 markets analysed by them. Geneva, Paris and Hamburg all saw transactions break through the 3% initial yield level. The same themes run across these Continental European markets, a lack of high quality new space and little sign of a supply surge with a handful of small exceptions. This market backdrop will be helpful in a post COVID 19 environment where demand will be deferred and/or reduced.

Paris, as the largest ofﬁce market in our universe warrants more detail. Take up at 2.1 million sqm was 6% lower than 2018 due to a smaller number of the largest transactions (+10,000 sqm). As importantly, the lack of take up in the CBD was actually a function of reduced supply, vacancy in Paris Inner City (the core of the CBD) was just 2.2%. However, not all sub-markets look that attractive. La Defense, traditionally a volatile market, saw no large transactions (over 20,000m²) in 2019 and where there is significant supply due in the next two years. Investment volumes reached €20.5bn, an increase of 7% on 2018 with 57 separate transactions over €100m. South Korean capital invested over €4bn.

Retail

It will come as little surprise that UK shopping centre transaction volumes reached multi-decade lows, totalling just £0.7bn of which local authorities (mainly buying in their own regions) comprised a third. The outlook for all retail continues to look bleak. I have written many times about the structural headwinds affecting the sector. Rents continue to fall as retailers trim their estates and rates (property taxes) don’t correct in line with open market rents so becoming an ever greater burden for property owners who desperately try to reduce vacancies with more concessions to potential tenants. With future income streams so unstable it is not difﬁcult to see why investors shy away and banks are nervous of lending.

Retail parks also continue to suffer signiﬁcant value corrections. Income uncertainty, particularly in a post COVID 19 world, is a real issue. In April 2020, Orion Capital walked away from its £21m deposit having contracted to buy £400m of retail parks from Hammerson such were their concerns about the value of these assets looking forward.

Online penetration continues its inexorable rise and is close to reaching 25% of all retail sales (ex food and fuel) in the UK by 2023 (Forrester’s research). Whilst this is a much higher level than any other European market, one feature of the lockdown has been the introduction of online purchasing to a whole new group of consumers particularly in markets with low levels of penetration such as Italy and Spain. Forrester’s estimate that Western Europe’s online sales will be 18% of total sales by 2024 up from 11.8% in 2018. Even prior to the current crisis investor appetite for European shopping centres was beginning to wane. Unibail had spent most of a year attempting to sell up to €5bn of French assets. With their year end results in February they were able to announce an agreement to sell a partial interest in a reduced portfolio of €3bn. Shopping habits have been evolving at varying paces across different cultural and demographic groups; this crisis has accelerated that evolution. Retailers and investors will all be responding to these changes in behaviour. However globally all retailers’ business models will continue to require a lot less space and at a lower cost.

Distribution and Industrial

The supply response to sustained demand particularly in the UK ‘big box’ units did reduce the rate of rental growth over the last 18 months. This return to more sustainable levels of rental growth is healthy. However last mile logistics across Europe, particularly in dense conurbation and suburban markets, remain highly sought after. For this relatively new form of property usage there are literally not enough suitable sites and rent is a modest element of the business overhead. Being in the right place is far more important. We experienced this ﬁrst hand in November with the lease renewal of our 50,000 sq ft ‘last mile’ logistics unit on the edge of Bristol. The new rent was agreed at 47% ahead of the previous passing.

European logistics take up also powered ahead reaching 26.5million sqm, 5% ahead of the ﬁve year average (Savills data). Vacancy rates remain below long term averages which is a surprise given the contraction in Eurozone manufacturing PMI data over the year. Our view is that structural shifts in supply chains and business practice remain a powerful force. Despite the well ﬂagged reduction in German automotive production, Poland – seen as a potential victim of that slowdown – recorded its second highest take up ﬁgure ever.

Investment levels remain elevated with transaction volumes reaching €36bn, 6% ahead of the 2018 ﬁgure. The weight of capital compressed yields by an average of 37bps. We don’t expect this to be repeated in 2020 given the heightened uncertainty but two key drivers remain in place. Firstly, the continued structural demand for logistics space and, secondly the acceptance by occupiers of long leases reﬂecting their capital spend on each site. These factors will maintain, if not fuel, investor demand for this asset class.

Residential

We have maintained our exposure to the private rented sector (PRS), with the bulk of our exposure in Germany but also Sweden, Finland and the UK. In Germany and Sweden rents are regulated (and below open market levels) and the value of these apartment buildings are below the cost of reconstruction. The rate of rental growth does bear some relation to open market growth rates and in sub-markets with rapidly rising private rental levels, such as Berlin, there has been a political drive to control the pace of growth even in regulated rents. Notwithstanding the Berlin situation we remain convinced that this sector offers both income security (close to 100% occupation rates) and rental growth.

In the UK, the number of households in PRS has more than doubled between 2000 and 2013 whilst the number of mortgaged occupiers fell by 1.5m (Savills). This reﬂected both increasing barriers to home ownership (higher deposits etc) but also the huge increase in ‘buy to let’ (BtL) amateur landlords. Over the last 4 years mainly due to changes in the tax regime the UK has seen a fall in the number of BtL units. Further regulatory changes which will reduce fees which can be charged to tenants, cap deposits and the abolition of no-fault evictions will further reduce this large, disparate group of private landlords. We expect a professional PRS to continue to grow rapidly and absorb tenant demand which is no longer catered for in the traditional ‘mom and pop’ operation. Compared to Germany and Sweden the professionalisation of the sector in the UK is embryonic. However it will grow and the underlying structural drivers of demand and lack of supply remain attractive.

Finland is a new market for us where we have invested through the recent capital raising in Kojamo. This long established (1969) business initially listed in 2018 and now has over 35,000 apartments primarily in the Helsinki region. Finland does not have rent controls and this business is at the forefront of digitising the residential management process driving up margins with occupancy of over 97%.

Alternatives

These sub-sectors are now a core element of the portfolio and include self storage, student accommodation, healthcare, supermarkets and leisure/hotels. Prior to the current crisis each of these subsectors was enjoying attractive (or at least ambient) market conditions. This was because they either offered long, often index-linked income (healthcare, supermarkets) or they were enjoying structural growth (self-storage, student accommodation).

During the year we saw heightened corporate activity with Unite, our student accommodation stock, purchasing Liberty Living (which we welcomed). Primary Health Properties acquiring Medicx was also a strongly accretive deal.

The COVID-19 crisis has driven huge divergence in the performance of this group with the healthcare and supermarket names being amongst the top performers in our universe whilst student accommodation and budget hotels have, as expected, suffered from a complete demand strike. In the case of student accommodation we expect recovery to be rapid once universities reopen but for hotels and leisure the process of growing occupancy will be much slower.

Debt and Equity Markets

The ongoing record low costs of debt meant that reﬁnancing remains a popular activity for a broad range of property companies. EPRA recorded £14.4bn of debt raised in the period which was a lower run rate than previous years and reﬂects the fact that interest rates have been so low for so long that companies have, in most cases, completed all the debt cost reduction they can. The prize for this year’s cheapest bond issuance goes, unsurprisingly given the negative rate environment, to a Swiss property company. Swiss Prime Site raised CHF 157m at 0.375% maturing in 2031.

There were no IPOs in the year but we did see £5.3bn of capital raisings. These were dominated by businesses raising capital to make corporate acquisitions. These included Vonovia raising €744m to aid its acquisition of Victoria Park in Sweden and Unite (£290m) to aid the purchase of Liberty Living. Healthcare names were also busy. Aediﬁca, raised €600m to acquire a UK portfolio (£450m). Primary Health Properties and Target Healthcare raised £675m between them to aid expansion.

Aroundtown, the aggressively expanding German commercial and residential investor was the most proliﬁc issuer of debt, raising a total of €3.0bn in a mix of straight bonds, senior unsecured and perpetual subordinated notes.

Property Shares

Property equity markets moved broadly sideways until late July when the background (rumbling) noise of the Brexit debacle once again rose in volume and pitch, driving investors away from UK domestic stocks. Property companies are a disproportionately large component of UK domestic ‘baskets’ due to their high level of GBP earnings. UK property names which had been weakening over the summer fell -7.5% in the ﬁrst two weeks of August. What was almost more surprising was the subsequent rally for UK property shares which then ran from mid August right up to the start of the COVID 19 crisis. Over the late summer and into the autumn, investors changed their views entirely with PM Johnson appearing to be more determined than ever to drive matters to a conclusion. The landslide Conservative victory in the December General Election under the slogan ‘Get Brexit Done’ gave them the mandate to do exactly that and a huge chapter of pan European history duly closed. UK property stocks continued to climb as the uncertainty dissipated recording +28% gains between mid August and mid February.

Continental stocks returned +22% over the same period which keeps the scale of the ‘relief rally’ in perspective. So, what drove property stocks upwards outside of the UK’s particular political situation? Once again the central banks have played a leading role in investor behaviour. ECB President Draghi delivered his parting shot, another rate cut and a renewed bond buying programme. More QE saw the 10-year Bund yield fall to -0.6% at the end of September and then rally into 2020 reaching -0.2% in early January. Whilst a signiﬁcant pricing rally for bondholders the nominal yield remained negative. Property income continued to offer a much higher yield than corporate bonds as well as an opportunity to participate in rental growth and development gains.

However this ambient economic environment came to a grinding halt in mid February as global equity markets began to price in the real threat from COVID-19. Between 19th February and 18th March, the pan European property equity benchmark fell -35.7% but then recovered somewhat to record a six week fall to the end of March of -26.5%. The last six weeks of the ﬁnancial year drove the 12 month returns from the sector (and this Trust) from double digit positive to double digit negative.

The sell off was hugely dramatic and market conditions since then have been immensely volatile. However at the stock and sub-sector level there has been a clear pattern of investment sentiment. With risk premiums rising and income sustainability falling investors have focused on those businesses with the strongest income proﬁles whilst avoiding the most leveraged entities. Healthcare, PRS, supermarkets, logistics have all outperformed whilst those businesses let to consumer facing companies have fared much more poorly. Non-food retail, leisure, bars, restaurants, cinemas and gyms have all seen a collapse in income. As investors are well aware, all shopping centre names had underperformed the wider property equity market long before this crisis as they continued to grapple with the structural shifts in consumer behaviour. We believe that this ongoing evolution will accelerate as safety (avoiding a busy shopping centre) joins cost and convenience as drivers of online growth.

Whilst the sell off since mid February has been very dramatic, the performance at the subsector level has been rational with investors focused on owning those businesses with the strongest income streams, and avoiding those which will experience the greatest valuation falls which may evolve to balance sheet risk. It will come as little surprise that German and Swedish residential names have performed well, not only in this crisis but also prior to it. With rents controlled below open market levels and occupancy at close to 100% the defensive characteristics are clear. The one area of concern is the political risk of even more stringent rent controls as we have seen in Berlin (covered extensively in the Interim Report) but we now believe the likelihood of contagion to elsewhere in Germany is low.

Scandinavian property companies were strong relative performers this year. Almost all Nordic property companies operate with higher leverage and shorter duration debt structures than the average pan European property company. The ongoing dovish response of the Riksbank (mirroring the ECB) was to supercharge earnings expectations given the strong performance of the Swedish (in particular) economy. As the current crisis evolved, we have been surprised at how well many of these companies with elevated debt levels have performed. The ‘light touch’ approach to lockdown and high quality healthcare systems coupled with lower population densities across the region have all contributed to better investor expectations.

Logistics and light industrial were already the sub-sector outperformers (again) as we entered the last quarter of the ﬁnancial year. Increased online purchasing as well as supply chain disruption will lead to greater demand for warehousing. Industrial based businesses will return to work before densely populated ofﬁces. The case for relative outperformance of companies such as Segro, LondonMetric, Tritax Bigbox, Argan, Warehouses de Pauw, VIB Vermoegen, Montea and Catena is clear. The issue is how far is this already reﬂected in pricing.

Investment Activity

Turnover (purchases and sales divided by two) totalled £440m, equating to 32% of the average net assets over the period. This compares to £262m (20% of average assets) in the previous 12 months. There were two major drivers of this increased turnover. Firstly, the Brexit debate in the ﬁrst half of the year resulted in signiﬁcant changes in our UK exposure. Added to this was the signiﬁcant degearing in February and March, only for reinvestment to take place in late March. The other major factor was heightened corporate activity. This year we saw the privatisation of Green REIT which was acquired by a private equity investor group, Henderson Park. At our peak position the investment reached 4% of net assets. The shares had traded at between €1.30 and €1.60 per shares for much of the company’s 4 year life. Management (large owners of equity) were, quite rightly, frustrated by the persistent discount to net asset value and put the business up for sale. The exit price was a very satisfactory €1.94 per share. Much more real estate is owned privately than publicly and if public capital markets won’t value it fairly then privatisation is inevitable. We are therefore drawn to businesses with family and management ownership where we see alignment. A&J Mucklow, the family run West Midlands industrial owner/developer was a case in point. The Trust owned 5% of the company and supported the agreed takeover by LondonMetric in May last year.

The residential sector remains a popular asset class and we saw multiple capital events. Kojamo in Finland raised capital after listing in 2018. Swedish neighbour, John Mattson was a small IPO of a Stockholm focused affordable housing landlord which rose 27% on its debut. Later in the year, another small Swedish residential business, Hembla was acquired by the German behemoth Vonovia. Back in Germany, ADO Properties which has a Berlin focused portfolio acquired Adler, the owner of lower quality residential units across Germany. We don’t own these businesses.

Elsewhere in Germany we saw a very convoluted series of transactions between Aroundtown and TLG, more akin to a soap opera. In series 1, we saw TLG acquire c.2/3 of Aroundtown’s founder’s holding at a signiﬁcant premium to the undisturbed share price. Attached to this deal, TLG announced a potential merger with Aroundtown but that would require a large capital raise given that they were the much smaller cousin. In series 2, minority institutional investors (such as us) are astonished to hear that the deal has reversed with Aroundtown now acquiring TLG. Due to the Luxembourg listing the transaction doesn’t require an EGM so minority shareholders couldn’t reach for the red button on their remote controls.

In Spain, we were pleased to see Arima announce a €150m raise with Ivanhoe Cambridge as a new cornerstone investor. We backed this business at IPO in 2018 which saw the return to the listed sector of the management team behind Axiara which was acquired by Colonial in 2018.

Revenue and Revenue Outlook

Earnings at 14.62p for the year were only marginally ahead of the prior year level of 14.58p. Although earnings at the interim stage were ahead of the prior year by some 6.7%, growth in the second half of the year had been expected to be slower than in the ﬁrst half and this was compounded by market events as the impact of the COVID-19 pandemic became evident. Investment turnover has been greater than usual in the current year, particularly in the second half. Portfolio repositioning reduced gearing and saw further reductions in exposure to a range of high yielding names particularly European retail stocks many of whom previously paid dividends close to our year end. In addition, the cancellation of the Landsec interim dividend (after it had been declared) close to the year-end added to the reduction.

Although these changes sacriﬁced some income in the year under review, the portfolio rotation increases exposure to sectors where we believe income streams are both more secure and sustainable. However these invariably carry a lower dividend yield.

Since mid March we have seen a range of further company announcements of either dividend cancellations, reductions or deferrals which will impact upon the forthcoming year. Our view is that some of these were precautionary as the companies evaluate their income risk and ensure their balance sheets are as robust as possible. We are also encouraged by the large number of companies who have reconﬁrmed their dividend forecasts and payout ratios. For the more precautionary names, we don’t expect the return to a clear picture of distributions until the path out of lockdowns across Europe has successfully materialised.

In our own direct property portfolio, we are well positioned, evidenced by a strong rent collection rate in April. Our non-food retail exposure is limited to two retail units and a gym, whilst our largest tenant is Waitrose. At Wandsworth we have some smaller occupiers exposed to the hospitality sector where we have negotiated rental deferrals or new lease terms. The overall expected drop in income from our direct portfolio is not material.

Although we expect the earnings to fall next year, as the Chairman has pointed out, as an Investment Trust we have the luxury of being able to call on income reserves to supplement dividends, until the longer term revenue pattern emerges.

Gearing and Debt

Over the ﬁrst 10 months of the ﬁnancial year, the levels of borrowing remained in a tight band of between 10% and 13% of assets. Through February and March the absolute amount of borrowings fell by £50m through short term loan repayments and £20m (notional debt) through the reduction in exposure through CFDs, but due to the dramatic share price reductions the gearing ratio only fell from a high of 13.9% in early February to a low of 5.2% in late March. In the last few days of the year the gearing increased again to 7.6%. Given the increased levels of market risk it may surprise investors that we had any gearing in the Trust at the year end. The physical portfolio accounts for 7.8% of our investment exposure and adjusting for that, the Trust was ungeared to the equity market.

It is important that we have the ability to gear when the conditions are favourable and, as the Chairman has commented, we added to the short term debt facilities available during the year with a new relationship and loan facility of £20m with the ICBC and adding a further £25m to our facility with RBS. In addition, a new derivative instrument which commercially is very similar to a CFD was added which has widened the counterparties available to us for derivative transactions.

Direct Property Portfolio

The physical property portfolio produced a total return of +8.5%, a combination of +5.3% capital return and income return of +3.2%. The capital return was driven by a variety of asset management initiatives across the portfolio from refurbishments, lease renewals and planning gains set off by reductions in the value of our city centre non-food retail units.

The sale of our ofﬁce building in Harlow, was reported at the interim. The property was sold for £10.5m which reﬂects a net proﬁt over the book cost of 3%.

At the Colonnades in Bayswater, we completed the refurbishment of the old public house which included the separation of the 3 bed ﬂat and the recladding of the pub. Towards the end of the year we completed the sale of the ﬂat for £2.02m which reﬂected a price of just over £1,500 per sq. ft. We were waiting for a sale of the ﬂat before marketing the public house which is an interesting space and will allow an occupier some really exciting ﬁt out possibilities.

As mentioned earlier, in February we completed the lease extension on our last mile logistics unit in north Bristol. The tenant has taken a new 5 year lease at a rent which reﬂects an increase of 47% on the previous rent.

The largest valuation gain was at our industrial estate in Wandsworth. We received, subject to a s.106 agreement, planning permission to redevelop the 35,000 sq. ft. industrial estate. The consent is for 106 residential units, 55,000 sq. ft of ofﬁce space and 62,500 sq ft of light industrial. The development of this mixed-use scheme will signiﬁcantly transform this dated 1970s industrial estate into a modern mixed-use destination adjacent to Wandsworth Town train station.

Outlook

At the time of writing much of the world is in the grip of the second phase of the COVID 19 dilemma. Infection and death rates have been brought under control through the strict discipline of lockdown and social distancing. However the huge economic cost of effectively furloughing vast swathes of the economy means that this strategy must now evolve quickly to restart business and consumption. The dilemma is over the pace, timing and focus of the relaxation of the lockdown across so many countries, each with their own set of particular issues. The lack of visibility makes forecasting extremely difﬁcult. However there are several market features which look sustainable. Firstly the commitment of central banks and governments (to varying degrees) to support the recovery. This means that the challenge from this crisis is less about liquidity and more about solvency. Which brings me to my second point. We will remain focused on those businesses where we are conﬁdent of the underlying tenants’ ability to pay. Borrowing will remain very cheap and banks will remain accommodative. At this stage we see the issue as one of tenant demand not leverage risk. At the sector level, some outcomes seem highly predictable while others are much more balanced. The structural shifts in consumer behaviour, particularly towards online retailing will, in our view, accelerate. Other behavioural adjustments such as increased home working would logically impact ofﬁce demand but that may be offset by reduced desk densities. Decentralised ofﬁces may prove more attractive than skyscrapers but such questions will be answered in years not months.

In the near term we will continue to protect the Company from those business strategies most at risk whilst acknowledging that income has become an even more precious commodity. The right type of real estate will continue to deliver that income.

On a personal note, I would like to extend a huge thank you to Hugh Seaborn for all his unwavering support and wise counsel over a great many years. He joined the Board in July 2007 just as we entered an earlier crisis and then guided us through further choppy times after becoming Chairman in 2016. He has been instrumental in assembling the current Board and their collective experience will be hugely important to the Trust as we weather this current crisis.

Marcus Phayre-Mudge

TR Property Investment Trust Fund Manager

28 May 2020