Investing in a UK recovery
Hugh Sergeant, manager of the ES R&M UK Recovery fund, talks to Darius McDermott about value...
The UK housing market began its lockdown easing last month, with people in England once again allowed to move house. Estate Agents were opened, viewings are now permitted and removal companies and other essential parts of the sales and letting process have been allowed to restart their activities – all obviously using social distancing.
This unlocking of the English housing market led to an immediate increase in online browsing and demand for sales as well as rentals. One week after the reopening of the market, Rightmove – a new holding in ES R&M UK Recovery fund – reported demand for rental property being up 33% compared to this time last year*, with Monday 18 May reporting the highest level of rental demand ever recorded in one day on Rightmove. Various sources seem to indicate that some 60-70% of stalled transactions* are now proceeding again.
And having seen increased demand, other fund managers are picking up bargains in the sector. VT Seneca Diversified Income has added to Purplebricks in the past month, for example.
It’s too early to assess where pricing levels will settle, according to Stuart Springham, deputy manager of TM home investor. “So far asking prices on resales, as well as house prices from new homes, seem to be holding up well,” he said. “Whilst a reduction in economic activity and increased unemployment will put downward pressure on house prices, this might be (partially) offset by the supply side.”
Stuart also points out that the Government continues with its broad range of fiscal stimuli – including the extension of the furlough scheme to October, or the 3 months extension of the mortgage payment holiday, with over 1.8m mortgages – 16% of all mortgages – in the UK now covered by it*. The government has also started consultation for a new ‘First Homes’ scheme whereby first-time buyers and key workers would get a 30% discount on new homes.
“As we have seen since the Brexit referendum, those who do not need to sell can simply stay put – resulting in lower transaction volumes but not necessarily in lower prices,” he said. “Housebuilders will adjust the release of new homes in accordance with demand.”
Ninety One UK Special Situations fund managers are firm believers in the housing sector.
They hold a number of stocks in this area, having added some in the recent sell-off. For example, holdings include Barrat Developments, Taylor Wimpey, Redrow and Bellway, as well as related businesses such as Howden’s Joinery, Travis Perkins and Grafton Group**.
In his recent podcast, Alessandro Dicorrado, told us: “The share prices of house builders, fell very significantly – more than 50-60% during the coronavirus crisis – because people rightly saw that housing construction came to a complete halt. But the good thing about the house builders is that while they closed down their operations, they consumed very little cash. Some of these guys can effectively not sell a single house for a year, 12-18 months even, and then just start up their operations again.
“The risk to the house builders is that house prices consistently declined from here. And that is a risk that we have to bear in mind as investors, because house prices declining means that they lose a lot of their profitability and their pricing power. But as long as house prices stay flat or increase, house builders will do quite well from here.”
Man GLG Income is also investing in housebuilders Redrow, Barratt and Bellway**. Its manager Henry Dixon said recently: “Having spoken to a number of the management teams in the sector we believe that current valuations – at a material discount to tangible asset value – imply a permanent -30% decline in house prices and no offsetting fall in the land price. With no debt, an ability to cut costs down to a minimum, significant asset value and government backing, we believe the risk-reward of the positions currently, well-below post Brexit referendum lows, is excellent.”
In terms of rental income, Stuart says it is holding up. “We are encouraged to be able to report 98% rent collection in May,” he said. “As a reminder, our ambition is to balance tenants’ and investors’ needs – wherever possible setting up payment plans to ease temporary difficulties. Our primary focus is on those who lost their jobs – once we have confirmation of a Universal Credit application, we work with the tenants to find a mutually agreeable solution. For tenants in furlough, we typically discuss temporary rent reductions couple with a repayment plan. Finally, we tend to delay rent reviews (typically rents grow with inflation) by a quarter. Over the past weeks, some of our tenants returned to work following a short period of furlough.
“Another priority are our vacant properties, including those from a recent acquisition near Birmingham. Since mid-May there were half a dozen viewings across our vacant properties [which were signed up to a portal looking to find urgent housing for NHS key workers at the height of the crisis] and we expect this number to increase over the coming weeks.”
In his recent podcast, Marcus Phayre-Mudge, manager of BMO European Real Estate Securities and TR Property Investment Trust, told us: “Our residential exposure is not really in the UK. It’s primarily in Europe, with the majority in Germany, but also in Sweden and Finland. If you could imagine buy to let on an industrial scale – that’s what we’ve got exposure to.
“The reason why this sector has done so well relatively in the Covid crisis, is that the rents are regulated. They are also inflation-linked, and in Germany where we’ve seen a lot of support for people who’ve been furloughed or made redundant, the companies we’re invested in have had incredibly high rent recovery rates. So not only are these portfolios of residential units fully occupied in most cases, they’ve also collected pretty well 100% of the rent. And that’s a real positive.”
Alex Ross, manager of Premier Pan European Property Share, concurred: “Rent collections for our holdings have proven to be resilient, particularly in the rented residential, healthcare and logistics sub-sectors.
“The most notable gainers in May were in fact in German residential, as results reported by these companies guided towards further valuation increases in their asset values, with investors seeking the highly resilient income yields available from this sub-sector. With negative bond yields prevalent across Europe and cash interest rates so low, the income produced by this sector is extremely attractive.”
*Source: TM home investor, May update
**Source: FE Analytics, full holdings as at 30 April 2020