Commercial property: embracing change

Jason Baggaley, Investment Manager, Standard Life Investments Property Income Trust Limited

  • Capital values and rental performance have proved resilient in the commercial property sector, despite some significant challenges.
  • The market for high street retail, shopping centres and poor-quality offices remains difficult, in stark contrast to strong demand for industrial properties and logistics.
  • This is a period of significant structural change that requires an active approach.

After the initial shock of Covid-19, the commercial property sector performed far better than many expected in 2021. Capital values increased and rental performance proved resilient. This, in turn, was reflected in a buoyant year for investment trusts investing in the sector.

However, it is also true that the aggregate performance of the sector masks pressure in certain areas. There can be little doubt that the market for high street retail, or poorly-fitted office space remains extremely difficult. The Standard Life Investments Property Income Trust has sold around £75m of assets over the past 12 months, a recognition that the pandemic has changed the landscape for commercial property and that capital can be redeployed more effectively elsewhere. This is a period of significant structural change and an active approach is required.

Selling is one option, but the Trust is also focused on strong management of the properties it holds. That means plenty of engagement with tenants to ensure the property meets their needs and refurbishing where necessary. Tenant expectations have risen over the pandemic. If employees are to be drawn back to the office, it will take more than a coffee machine and mints on reception. At the same time, industrial groups want proper automation and efficiency at a time when they are facing rising cost pressures.

Environmental, social and governance (ESG) considerations are becoming vitally important in the commercial property sector. Commercial property groups that are left with buildings that don’t fulfil ESG criteria and can’t be improved might struggle to deliver performance and may be left with ‘stranded assets’ – assets for which there is no resale market and no obvious tenant base. The right assets will deliver a growing and sustainable income stream and this is where we need to gravitate.

This isn’t an easy path. A fully considered approach is needed for the transition to a low carbon portfolio, with careful choice on timing of intervention to aim to provide investors with returns, and occupiers with the space they need. New techniques and technologies are evolving, and care is needed not to replace existing equipment whilst it is still operating well, or before a better solution is available. The grid capacity may not be sufficiently robust to support full electrification, for example. At each stage we take an informed approach, drawing on internal and external expertise.

Finding the right property

As we look to deploy the cash from recent sales and rebuild the portfolio, ours is a considered approach, waiting for the right opportunity. This has hurt our income stream a little over the past 12 months, but we believe it will ultimately build a far more sustainable income in the longer term.

In a period of structural change it is important to be invested in the right areas of the market. We are benchmark agnostic, and are happy to invest across lot sizes to where we see value. We continue to like logistics assets and have recently made two acquisitions in this area, however in a sector favoured by so many we are being careful to invest in assets that have strong ESG credentials, and the right specification for occupiers. We are also looking at retail warehouse investments. The retail sector has of course had well known issues, and we still don’t like the high street or shopping centres, however food and budget-led out of town retail parks make up most of our retail exposure, and we are happy to add to that holding – on an asset-by-asset basis. Offices are an area of considerable debate – the way in which they are used and the overall level of demand is changing fast. We have undertaken a review of the portfolio and sold four offices that we did not think would meet future requirements, and as and when we reinvest in the sector, it will be very targeted on assets that we believe can be ‘future fit’.

In a period of considerable structural change, and one where there is still a large weight of money seeking to invest in the sector, we remain focussed on the assets we like. We are quite happy to buy into an investment where an intervention (such as major refurbishment, upgrade or even development) is required as we can utilise the extensive experience of the abrdn asset management team to identify opportunities.

We know that past performance is no guide to the future. In this period of significant structural change, it is important to keep adapting the portfolio. We are building a ‘future fit’ portfolio ready for the changing demands of tenants.

Important information

Risk factors you should consider prior to investing:

  • The value of investments and the income from them can go down as well as up and you may get back less than the amount invested.
  • Past performance is not a guide to future results.
  • Investment trusts are specialised investments and may not be appropriate for all investors.
  • There is no guarantee that the market price of a Trust’s shares will fully reflect its underlying Net Asset Value.
  • As with all stock exchange investments the value of the Trust shares purchased will immediately fall by the difference between the buying and selling prices, the bid offer spread. If trading volumes fall, the bid-offer spread can widen.
  • Investment trusts can borrow money in order to enhance investment returns. This is known as ‘gearing’ or ‘leverage’. However, the use of gearing can result in share prices being more volatile and subject to sudden or large falls in value. Where permitted an investment trust may invest in other investment trusts that utilise gearing which will exaggerate market movements, both up and down.
  • The value of tax benefits depends on individual circumstances and the favourable tax treatment for ISAs may not be maintained. If you are a basic rate tax payer and you do not anticipate any liability to Capital Gains Tax, you should consider if the advantages of an ISA investment justify the additional management cost/charges incurred.
  • Property values are a matter of the valuers’ opinions and can go up and down. There is no guarantee that property values, or rental income from them, will increase so you may not get back the full amount invested. Property investments can take significantly longer to buy and sell than other investments, such as bonds and company shares. If properties have to be sold quickly this could result in lower prices being obtained for them

Other important information:

Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1XL. Registered in Scotland No. 108419. An investment trust should be considered only as part of a balanced portfolio.

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