Quarterly Investor Report 31 March 2017

We have pleasure in providing our latest quarterly report where we explore the challenges facing the economy and the property market as the global political landscape changes.  In addition, we report the performance of Keills Property Trust as reported by MSCI.

Economics and strategy

On the world stage we now have a new US president in office battling with the practicalities of taking forward some of his populist policies.  So far there has been little change and markets are beginning to ask whether the Trump rally has run its course and if he can’t change Obamacare, then will he be able to change taxes?  Trump has now moved on to discuss foreign policy, in particular, North Korea.  The recent visit by China’s President Xi to Florida was a start of this process, albeit interrupted when Trump fired 59 Tomahawk missiles at a Syrian Air Base, in response to the supposed use by the Syrian Government of sarin gas.

Populism was again challenged in Europe where, in Holland, a centrist party was re-elected.  In France, Marine Le Pen is expected to win the biggest share of the vote in round one of the French elections on 23rd April.  Markets are pretty sure that at the next stage, two weeks later, the more centrist parties will prevail.  Similarly in October Germany goes to the polls.  In both France and Germany we expect the status quo to prevail but following the turmoil of 2016, the world could yet be surprised.

   

On 29 March, the UK’s Prime Minister wrote a letter to EU President Donald Tusk formally starting the Brexit process.  By Friday 31 March the EU had responded and set out its negotiating stance which will be confirmed after the EU meeting for a special Brexit meeting at the end of April.

Expect your chosen newspaper to be full of the ‘he said, she said’ chat covering every aspect of the negotiations over the next two years.  Perhaps our politicians are secretly hoping that their plebiscite will be bored stupid over the next two years, enabling a very hard Brexit or maybe offering another opportunity to vote again on any eventual deal.  We have two years to wait.

Meanwhile, the global economy grinds on and debt continues to rise.  Output is sufficiently up in the USA that many now expect at least two, or possibly three, interest rate increases in 2017.  We think that it is more likely to be two and believe that as rates climb, the cooling effect of current debt levels will prevail.  On this side of the Atlantic we expect rates to remain flat given the uncertainties of leaving the EU.

The “Alice in Wonderland” economics prevails, with bond yields remaining close to record lows (on a three year view). This is despite the US intimating that yields have turned, all the uncertainties in the world regarding a new US President finding his feet and all of the known unknowns of Brexit.  The path of global growth and inflation is at best uncertain so it is hard to argue against the market.

UK Property

We remain confounded by the number of cranes in London and also the continued pressure to build higher.  While some of the current towers being built are for residential use, history tells us that this level of development has in the past ended in tears.  The question we have been trying to answer is what will be the trigger to call a halt to the boom?  Maybe Brexit?

According to Deloitte, in their latest London Office Crane Survey, the total volume of office space under construction is 14.8 million sq ft and of that some 41% is already let.  Or 59% is unlet.

As a result of the time taken to build space, the peak in delivery of new space has now moved out to beyond 2017.  London offices are therefore at a critical time not helped by the uncertainty caused by Brexit.  There is already evidence of developers offering increased incentives to tenants, often seen as the prelude to rents themselves falling. Interestingly and not surprisingly, most of the available space is focussed on the financial services sector, which if the noises coming out of Brussels are any guide, could be hit the hardest by a hard Brexit.

There are two sides to the Brexit argument and of course there may in fact be stronger growth following Brexit which will mop up the excess space available.  We would simply point out that the schemes available today did not know the outcome of the Referendum vote never mind the outcome of Brexit itself in two years’ time, when the schemes started.  Time will tell but we feel we could be in for some good old demand and supply economics.

Our ‘risk-off’ view on London is backed up by the latest Investment Property Forum forecasts which point to falling rents at the UK level through 2019.

Our bearishness is tempered by the continued global search by investors for safety and yield. London is still the pre-imminent location for global real estate investors who are often looking for somewhere safe to park money rather than simply seeking a return.

For mature pension investors, which includes many of the members of Keills Property Trust, collecting rent from a 20 year lease and delivering an income return of say 4% makes a lot of sense particularly, when any liquidity issues can be ignored.

A couple of years ago we moved away from describing the different sectors of the market and we see no reason to change this approach.  In the new ‘yield is king’ world it would have been far more advantageous to chase the highest yielding sector rather than seeking out increasingly elusive rental growth.  We believe that UK Property is still attractive on a yield basis against other assets, as shown in the table below.

Where to get an income return?

Asset UK Property 10 year gilts 10 year US Treasuries FTSE 100 dividend yield
April 2017 5.3% 1.03% 2.22% 4.11%

Sources: MSCI, FT

STOP PRESS

As we go to press, Theresa May, Prime Minister, has just announced plans to hold a General Election on 8 June.  So, when we write again, it is likely that the UK will have a new government.

New property bought

Keills Property Trust completed on the purchase of another asset at 31 March 2017.  The deal was a sale and leaseback of a warehouse in Royal Wootton Bassett for a price of £4million, at a net initial yield of 5.75% on a new 20 year lease.  The rent is reviewed to the Retail Prices Index every 5 years, subject to a minimum annual increase of 2.5% capped at 5%.

Annual MSCI Report

We receive an annual analysis of Keills Property Trust’s performance and a copy can be downloaded from our website at www.keills.com  It is pleasing to note that last year the total performance at the property level was in the 9th percentile as measured by MSCI.  More pleasing still is the income yield premium over the market yield which investors receive and which will increase as our rents grow independently of the growth in rents generally.