Quarterly Investor Report
Economy & Strategy
Keills Property Trust | 31 March 2016
Quarterly Investor Report 31 March 2016
Economy & Strategy
The market gyrations for anyone invested in equities or bonds have been stomach churning in the first quarter of 2016. A commodity rout, focussed on oil and metals, pushed oil down into the mid $20’s per barrel before recovering to c$40 per barrel. Cheap oil, as we have stated here before, should be a good thing for business and consumers alike, much like a one off tax cut. The bond markets thought otherwise and saw the rout as an indication of weaker global demand. Government debt yields slid to reflect this and Japan joined the expanding group of countries where 10 year debt was at negative yields. As a consequence, the UK and USA bond yields now seem relatively high.
More recently, Ireland borrowed $100million for 100 years at a fixed rate of c2.53%. Such has been the rehabilitation of Ireland within the mainstream investor that the offer was oversubscribed. While other countries have been kicking the can further down the road, in terms of dealing with the debt overhang, Ireland took a different approach, cutting incomes and rebasing to a more sustainable level. It is truly remarkable and can only reflect the markets clamour for certainty in a very uncertain world.
Global politics is going through an interesting period with plebiscites increasingly looking for some direction and getting tired of zero wage inflation, a lack of redress against bankers and an outlook which is at best, cloudy. The Great Muddle Through.
At this stage we would normally depart to our sometimes repetitive diatribe on markets. Instead, we want to consider the UK’s preparedness for a global economic shift. What happens if the Chinese debt balloon were to burst, resulting in investors clamouring for liquidity? With UK, Japan and USA Government balance sheets all loaded with borrowing liabilities, how would these countries cope with such a shock? There is no obvious answer, but printing even more money would appear to be a favoured response. We would ask, “Is this not simply repeating previous mistakes?”
An alternative, with what many would view as being a change of direction, may be to invest further in long term assets such as HS2/3 and Crossrail. Continuing further projects of this type could be done with a view to stimulating demand, increasing wages and most importantly increasing inflation. The sharp increase in the price of index-linked government debt over the quarter may indicate that markets are beginning to think this way.
By the time we publish our next quarterly report, the UK will have voted on whether it should remain in the European Union or not. The question posed by the referendum is complex and not easily understood by the man on the street, politicians or fund managers. Our take, is that we are probably better off In than Out and that by remaining In, we at least have a chance of having a say in what goes on. Norway for example, has most of the financial and regulatory costs of dealing with Europe, but has no say on the rules it has to follow. Add to that, the fear of the unknown if the UK were to operate outside the European Union and the argument to remain is persuasive.
The UK All property initial yield stood at 4.98% at the end of February 2016 with rental growth running at 4.41% to the same date. Yields have been falling modestly while rental growth, driven by strong performance in London and the South East, has also picked up slightly.
We expect yields will continue to fall, reflecting the increased weight of money targeting the asset, but we do not expect rents to grow much higher than this rate, if at all. The effect of an income return of c5.5%, plus this level of rental growth and yields hardening, will again produce total returns into double figures over the next year.
There is anecdotal evidence of retail investors beginning to pull money out of open ended funds, wary perhaps of not wishing to be the last investor in and being ‘trapped’ as values turn south. With yields still higher in nominal terms than in 2007 and significantly higher in relative terms to other assets, we suspect that these investors are probably leaving early. If property gives up 6% to 8% on a total return basis over the next 5 years, then we say “be trapped”. Long term investors, such as pension funds, should have very limited need for liquidity if they are honest about their liabilities, which often extend several generations into the future. Meantime, these same investors can pick up a useful net income return of c 5.5% which should generously outperform their fixed income portfolio, whilst also offering some inflation hedging for a later date.
As regular readers will be aware, we coined the term RPI Property to best describe our investment strategy. Keills Property Trust focusses on UK property, where rents increase in relation to the Retail Prices Index, the Consumer Prices Index or by fixed increments all written into the lease. In this way, our clients are insulated from market movements in rents. By selecting good quality tenants, we can be reasonably assured that our rents are paid timeously.
The Natural Home
In addition to the qualities necessary to qualify as RPI Property, we stick to the fundamentals of good property investment and try to ensure that our assets are the “natural home” of the tenant. Defining the “natural home” may vary from one location to another but essentially, we believe that there are reasons, other than simply having a lease in place that will make a tenant to want, or need, to be in a particular property. This is a very sustainable way of investing, which we believe will deliver positive returns over the coming years.