The gap in returns between REITs and open-ended property funds remains wide as economic recovery starts to have an impact on the investments.
Investec analysed seven REITs (AEW UK REIT, Schroder Real Estate Investment Trust, UK Commercial Property REIT and Standard Life Investments Property Income), and found the net asset value total return ranged from 3.9 per cent to 10 per cent in the second quarter this year, averaging at 5.7 per cent.
This was in comparison to the MSCI Monthly index, which saw a return of 2.6 per cent in the same time period.
It said the recovery of the UK economy represented a “more supportive environment” for commercial real estate and was driving a rebound in valuations, which had fallen sharply at the beginning of the pandemic.
The UK economy grew by 4.8 per cent in the second quarter of 2021 as Covid-19 restrictions were loosened, after contracting 9 per cent between February 2020 and January 2021.
But not all benefitted from this trend equally. Returns for the institutional share class of the 10 largest open-ended property funds were 1.7 per cent on average, with individual performances ranging from -4.3 per cent to 4.9 per cent.
Investec said the difference in investor experience between investment companies and open-ended funds was stark.
It said: "The fortunes of investment companies and open-ended funds continue to differ markedly, with the average Q2 NAV total return of investment companies featured...some 400bps ahead of the average of the ten largest open-ended funds.
"More importantly, over the long-term, the closed end sector has delivered far superior total returns, and also a much higher dividend yield.”
It added while there has been a recovery in the sector in the past year, most real estate investment companies were still trading at a discount to NAV.
It said: “If UK commercial real estate performs in line with expectations, or if the closed end sector can attract a small proportion of the monies currently leaving the open-ended sector, then we see the potential for a further improvement in ratings.
“We strongly believe that structural advantages of investment companies should underpin superior returns and relatively attractive income characteristics.
"For more illiquid asset classes, such as commercial real estate, the long-term differential may be meaningful."
Structural flaws
Investec said the poor performance of open-ended funds was due to the “dragging anchor” of structural flaws.
These flaws include the mismatch of liquidity between the daily traded open-ended property funds and the underlying assets they invest in.
This has resulted in almost all funds gating for investor redemptions periodically over the past ten years, including during the pandemic.
The Financial Conduct Authority has been running a consultation into creating a new fund structure for illiquid assets, however the results of this were delayed until later this year.
Aggregate total assets of the 10 largest open-ended funds have fallen from £13bn to £8.7bn in nine months, according to Investec, which estimates that £1.6bn of the remaining assets are held in cash.
These funds will hold cash to ensure they can fulfil investor redemptions, however this increases the drag on the fund’s performance.
sally.hickey@ft.com
