Investment trusts can be a great way of investing in property, given the relative illiquidity of property as an asset class and the long-term time horizons it entails. That's why real estate investment trusts (REITs) have flourished since their introduction to the UK market in 2007.
But not all REITs are equal. Given the opportunities for active asset management that commercial property affords, we believe that specialist REITs can offer considerable attractions over generalist, benchmark-constrained REITs.
Commercial property is a diverse asset class. Accordingly, its component sub-sectors will often diverge widely from each other in their performance and prospects. At any given time, certain areas will languish while others flourish. But REITs that follow a standard property benchmark will be shackled to the languishing parts of the market rather than focusing on the flourishing ones. Specialist REITs, on the other hand, have no such constraints. This means that they can focus on the areas where the managers believe valuations are most attractive and prospects are brightest.
This is especially important with UK REITs because of London's inevitable dominance of benchmark indices. For example, following a standard property benchmark means accepting high exposure to the London office sector. But this is an area that faces less certain prospects in the run-up to Brexit. Meanwhile, conventional high-street retail also looks unattractive as it wilts in the face of online competition. And while big logistics warehouses have done well in the past, they now look distinctly overvalued.
But rather than simply accept that an allocation must be given to each of these areas, specialist REITs are able to avoid them. Specialist REITs don't subscribe to any property relative return benchmark and are free to focus on the areas where they see the greatest potential for sustainable income and steady capital growth. That's a huge advantage in such a diverse asset class. At Ediston, for example, we currently focus on the retail-warehousing sub-sector, which is benefiting from the current shift towards e-commerce.
Another big advantage of specialist REITs is that they tend to be smaller. This allows them to be much more flexible and nimbler when shifting weightings between sub-sectors, because they have fewer properties to buy and sell. They have a much smaller ‘turning curve' than their larger peers. This is important as no asset class stays the same over a given period, and it's possible that managers will want to shift allocations in anticipation of the changing fortunes of various sub-sectors. A large REIT can be unwieldy and struggle to do this within an appropriate timeframe. In contrast, their smaller, specialist counterparts can be better equipped to reflect the evolving market environment.
But perhaps the most important advantage of specialist REITs is their ability to add value through asset management initiatives. Specialist REITs are small enough to engage in the active management of every asset in the portfolios that they manage. At Ediston we are heavily focused on enhancing our assets which requires a hands-on approach that larger REITs are often unable to undertake, allowing us to get more value out of each property.
We believe it is crucial to monitor every aspect of our portfolio and we do not leave holdings to look after themselves. We are actively involved at every level of the process - from developing new properties to ensuring that existing tenants are satisfied and that no opportunity for improvement is missed. Because specialist REITs tend to be smaller and nimbler, they are able to invest in properties that don't meet the criteria for larger institutional investors and then develop them until they do. For us, there is an opportunity to unlock a substantial increase in value by eventually selling these assets on to institutional investors, which is often beyond the reach of more cumbersome competitors.
This is where companies like Ediston bring the benefits of their experience to bear. Being tightly focused and highly resourced, managers are able to focus their efforts on between three and six assets each. In a broad field like the UK property market, a narrow focus provides a crucial edge.
Calum Bruce, investment manager of Ediston Property Investment Company