Standard Life Investments Property Income Trust

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1 Standard Life Investments Property Income Trust is a client of Kepler Trust Intelligence. Material produced by Kepler Trust Intelligence should be considered as factual information only and not an indication as to the desirability or appropriateness Standard Life Investments Property Income Trust Summary Standard Life Investments Property Income Trust ( SLIPIT ) aims to generate an attractive income with the potential for income and capital growth from investments in UK commercial property. Over the last five years it has produced the second-highest NAV returns in the sector while generating an attractive yield; the yield of 5.3 is still above average. The portfolio is biased towards industrial assets and very underweight retail, as the manager, Jason Baggaley, thinks the latter sector is facing secular and shorter-term headwinds. Jason is cautious about the outlook for the UK economy, which means he is focusing on high quality, resilient assets and has reduced significantly the gearing on the trust. The trust has fallen to a discount of 2 from a premium of 5 in the market sell-off since the start of September, even though it has continued to generate returns above that of the market. Portfolio SLIPIT aims to generate primarily an attractive level of income from UK commercial property, along with prospects of income and capital growth. The trust invests mainly in the three major commercial property sectors: industrials, retail (including leisure) and offices, and can invest up to in other segments. Fig.1: Asset Allocation Offices Retail Source: Standard Life Investments SLI: Sector exposure Other As at Industrial The trust s portfolio has become increasingly tilted towards industrials in recent years. This is driven by Jason s focus on income, but also his view that this sector is more sheltered from the effects of the internet than retailers and potentially more sheltered from the impact of a turn down in the UK economy also. Update 12 November 218 Analysts: William Heathcoat Amory +44 () Pascal Dowling +44 () Thomas McMahon, CFA +44 () William Sobczak +44 () Kepler Partners is not authorised to make recommendations to Retail Clients. This report is based on factual information only. The material contained on this site is factual and provided for general informational purposes only. It is not an invitation or inducement to buy, sell or subscribe to any product described, nor is it a statement as to the suitability or otherwise of any investments for any person. The material on this site does not constitute a financial promotion within the meaning of the FCA rules or the financial promotions order. Persons wishing to invest in any of the securities discussed in the website should take their own independent advice with regard to the suitability of such investments and the tax consequences of such investment. 1

2 As of the last reporting date in September 218, 54 of the portfolio was held in industrials, compared to 28 in offices and 11 in retailers. Of the retail holdings, the bulk is in retail warehouses rather than high street units. These out of town retail parks are considered more resilient to the challenge of the internet. The 7 in others includes a 218 purchase of a data centre on the outskirts of Birmingham with an in situ tenant on a 2-year lease and rents linked to inflation. The initial yield was 7. Geographically, over 4 of the properties by value are in South East England; most of this is office space. Most of the holdings outside the South East are industrials, with the latter tilted to the East and West Midlands. There is no exposure to Wales and minimal to Scotland, although this was increased in October with the purchase of an industrial site in Glasgow. The trust has minimal exposure to central London, having reduced it in 217 by selling White Bear Yard, Clerkenwell in March of that year. Jason fears that there are signs of over-supply in central London office space, which are compounded by the uncertainty caused by the Brexit vote. However, he did purchase a 12.15m multi-let office and retail unit in the City in July, lured back into the market by attractive pricing on that asset. In this case, the property was bought at a yield of 7 with a rental guarantee top up, and 4.7 without the top up, and at a price in line with recent transactions of entirely vacant properties. The valuation was therefore highly attractive, and Jason sees the opportunity for asset management initiatives to increase its value through improving the two vacant floors. The purchase therefore illustrates two key concerns of Jason s process: a focus on strong income generation capabilities and an eye for asset management initiatives. In the first half of 218, seven new lettings were completed securing 1.13m in rent a year, and six further leases were renegotiated to extend the term, securing 75, in annual rent. In recent years, Jason has been willing to take on properties with part vacancy if he thinks there are good prospects for reletting at a higher rent with some asset management initiatives. Jason believes that the retail sector is facing tough times, and his exposure has been reduced in recent years. However, he does believe some locations in the South East and central London have better prospects. The growth in online shopping is making it increasingly hard for high street retailers to compete, while young people are less likely to own cars and visit out-of-town shopping centres, reducing their attractiveness. In addition, Jason s wariness on the outlook for the UK consumer after several quarters of sub-inflation wage growth and continued uncertainty around Brexit make him reticent to take on retail exposure. Where he does have exposure to the sector, he insists on it being in high quality properties. In the first half of 218 the trust saw two tenants go into administration: Maplin and Poundworld. However, the Maplin unit has already been re-let, while the Poundworld unit has seen interest from three retailers, meaning the focus on quality is protecting shareholders as intended. In fact, the manager is focusing on quality assets across the whole market, as he still thinks the macro uncertainty could create a headwind for commercial property. Over the past two to three years he has been reducing his exposure to properties with expensive capex requirements and letting voids. In 218 the company sold its largest void, an industrial property in Oldham, and also sold Elstree Tower in Borehamwood, which was to require significant capex and housed a tenant with a 22 break clause. Furthermore, low levels of unemployment mean that employers prefer quality higher grade properties as a means to attract and retain staff, another reason for Jason to focus on high quality assets. Jason says he is investing with ever greater caution due to his concerns around the UK economy. This is not just a matter of Brexit uncertainty, and Jason does not think that March will bring a resolution to our problems either way. He is prioritising assets which will be resilient through difficult times and expects income to be the main source of returns to the market in the near future, rather than capital returns. The focus on selecting quality assets means that Jason is willing to take on shorter-term tenants to boost the yield of the trust. This is a risk, but Jason believes that if the quality and location are right then there should be little problem in either persuading existing tenants to prolong their tenancy or finding new tenants. Voids in the portfolio have fallen to 5.5 from 7.7 at the start of the year after the sale of the Oldham unit and the leasing of an industrial unit in Rainham in January, which had accounted for over a quarter of the company s voids. Gearing Jason s wariness about the UK economy and property market has led him to reduce gearing since the Brexit referendum. Overall borrowings fell from 26 of NAV at the end of 216 to 18 at the end of 217. The company has paid back all of its short-term debt it has the ability to borrow up to 35m from RBS and has 9m uncommitted cash. However, the company has structural gearing by way of a 1m loan maturing in 223. The rate payable is fixed at 2.7, which is the lowest of its UK direct property peers fixed debt, according to JPM Cazenove figures. 2

3 The manager has reduced the interest rate risk associated with this loan by entering into an interest rate swap. As the company has to pay LIBOR plus a given rate on its loan, it has entered into a swap to receive LIBOR in return for paying This locks in a given yield over the life of the swap and means the trust cannot be blindsided by sharp rises in interest rates forcing it to pay a high rate on its debt. This hedge was implemented in April 216 before the Brexit referendum caused the Bank of England to slash rates and slowed the expected gradient for the hiking cycle. Arguably this was poor timing and the hedge is currently marginally out of the money but, assuming the debt is held to maturity, will revert back to zero and in any case provides certainty to the manager as to his commitments. Returns SLIPIT has produced the second-highest NAV total returns in the peer group over five years behind Picton Property Income. The trust has made 7, compared to a sector average of 54. Fig.3: Performance SLI: Performance versus index Standard Life Inv. Prop. Inc. (NAV) Morningstar IT Property (NAV) Fig.4: Returns Jan '18 Apr '18 Jul '18 Oct '18 Standard Life Inv. Prop. Inc. (Price) SLI: Discrete annual returns (calendar year) Fig.2: Performance SLI: Performance versus index Standard Life Inv. Prop. Inc.(NAV) Morningstar IT Property NAV Standard Life Inv. Prop. Inc. (NAV) Morningstar IT Property (NAV) Standard Life Inv. Prop. Inc. (Price) Over one year, NAV has risen 12.2 compared to 8.1 from the sector average. Outperformance of the index was helped by the manager s preference for industrial assets, which outperformed, and his underweight to retail sites, which underperformed. On a capital basis, NAV grew 4.3 in the nine months to the end of September, with a further 4.1 return coming from the three dividends declared so far. As the chart below shows, the trust has beaten its peers in six out of the last eight calendar years. Jason has managed to generate high levels of income from assets which also produce good medium-term capital gains. In 216, strong income generation helped the trust post positive total returns despite a fall in capital values and the trust lost less in capital terms than the index. In 217, capital growth was in line with the market, but the income returns were superior. Jason believes that income growth will be increasingly important to returns in the near future as the outlook for capital returns in the market is limited. Dividend Generating an attractive level of income is one of Jason s primary aims. The trust offers a solid yield of 5.3, putting it among the best earners in the Morningstar IT Property- UK Direct sector, largely thanks to the team s significant boots on the ground, which allow it to pursue smaller unit sizes and take the risk of shorter leases, which generate higher yields but need more frequent renewals and therefore more man-hours. 3

4 The trust pays quarterly, and the third quarter dividend of 1.19p to be paid in November is in line with the forecast 4.76p for the year. Dividends have grown by 5 over the past five years, but have been held flat since 216. Fig.5: Dividend Source: Aberdeen Standard NB: 218 dividend forecast Dividend cover slipped to 83 in the first six months of the year from 4 in December 217 thanks to Jason restructuring the portfolio in line with his more cautious outlook and selling assets with limited future return potential but higher yields. However, the cover rose to 95 by the end of September, and the board views improving the dividend cover as a priority. The two transactions since 3 June have improved the situation: the company sold its largest void, worth 1.7 of estimated rental value, and purchased an industrial property in Cambuslang on a yield of 7. Management SLI: Annual dividend (financial year) DPS EPRA EPS Jason has emphasised to us the importance of the people around him as not only is he supported by four portfolio managers, but he also has access to a large support team, which takes care of accounting, tax, marketing, research and (unusually in the sector) rent collection. This allows for a very active approach, with Jason and the team able to meet regularly with tenants (instead of using agents) and have a greater feel for the underlying trends within the market from a micro level. This hands-on approach is used to try and drive shareholder returns and keep void rates low, as by interacting with tenants face-to-face, Jason argues it offers better opportunity for refurbishing assets and extending leases as the team has a greater understanding of the tenants businesses and can better meet their property needs. The recent merger between Standard Life and Aberdeen Asset Management will provide additional resources in due course. At the moment most of the synergy between the two is in information and knowledge sharing, and the processes of and people on the fund remain the same. In our view the merger will likely be positive in expanding the pool of resources and expertise the manager can draw upon. Discount Thanks to its income profile and strong NAV total returns over the years, shares in SLIPIT have been in high demand, trading on a premium for most of the past five years. However, in the global market sell-off which began in September, the trust has fallen onto a discount for the first time since the aftermath of the Brexit referendum in 216. It now trades on a discount of 2, which is tighter than the 2.9 sector average. It should be highlighted that pre the shares moving to a discount, SLIPIT was able to issue 11 million shares in 218, raising net proceeds of.2m at prices that were accretive to NAV. Fig.6: Discount Charges SLI: Discount / Premium Standard Life Inv. Prop. Inc. Morningstar IT Property Ongoing charges were 1.7 for 217, which compares to a peer group average calculate by the AIC of The management fee is.75 of total assets up to 2m,.7 of total assets between 2m and 3m and.65 of total assets in excess of 3m. 4

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