REITs and Listed Infrastructure Funds

Since the beginning of the year, we have been allocating approximately 30% of the portfolios of the European and North American Funds to liquid securities. The liquid securities allocation of our Long Income Fund, however, is still at 7.08%, away from the 20-30% target we usually set for our Funds, keeping us in acquisitive mode.A number of UK REITs on our buy list announced capital raising to fund their healthy acquisition pipelines, offering an opportunity to increase our exposure, either by participating in the offering or soon after in the secondary market.In the past, new capital raises have proven a good opportunity to increase exposure in these REITs, as these offerings are usually done at a discount to prevalent secondary market prices and are then followed by strong positive performance as the raised money is deployed in accretive acquisitions which boost NAVs, EPSs and dividends.Among these REITs raising capital, we particularly like those investing in UK and Continental European Logistics, a sector where we see strong rental growth and increasing compression of yields.Whilst it is challenging to make direct investments in standing assets at entry yields of 3-4%, indirect investments via REITs benefit from access to a development pipeline which enables us to capture yields on cost of 6-8%. Most of these developments are non-speculative, but rather consist of pre-let properties to Retailers who are shifting their business online and require more Logistics space to replace the traditional space they are vacating on the high street or in shopping malls. We also plan to add UK Diversified Long Income REITS which seem to have turned the corner in respect of the difficulties they had last year with their exposure to the Budget Hotels and Leisure sectors, and are now coming back to market to raise fresh capital to finance their acquisition pipeline (primarily in the Supermarkets and Logistics sectors).UK Supermarkets is of course one of our favorite themes, but we won’t be active in the listed sector this month and next, since we are planning to make a number of direct investments (see below under the relevant section).The Office sector, and in particular London Offices, is in our opinion best played through REITs at the moment. There has been virtually no evidence of distress in the direct market, and the only place to buy below fair value is the stock market.Offices have been virtually empty for the last 12 months, and there has been very little activity in the letting market to establish with certainty if (and how) demand from users has changed as a result of this forced “work from home” experiment. Various surveys we have read lead us to believe that users want increasing flexibility which is best addressed by flexible offices. It is for this reason that we plan to increase our exposure to flexible office REITs which in our opinion are best placed to capture this long term trend. Nevertheless, it is undeniable that some of the traditional REITs providing exposure to Offices are still trading at a discount to NAV and we have been tactically attracted to this sector during the month of March. However, a full return to Offices will need to wait until later in the year or even early next year, when occupancy trends should be clearer. We think that much of the repricing of Office REITs over the last couple of months is due to hopes that things will return to normal, or that they will not be as bad as feared, with very little evidence of what is really happening on the ground. We doubt that valuations will hold in the face of falling rents and capital values. We certainly have seen this happening with Shopping Centers REITs which rallied on the back of the positive news of the discovery of a vaccine, only to give up most of the gains when it became evident that things were not returning to normal any time soon.We also plan to increase our exposure to the Self Storage sector. It has taken a while to find a reason to invest in this space given the uncertainties about new supply of self storage space. However, when we saw reports that commercial use of self storage facilities has been increasing to 25%, we realized what is actually going on: the limited availability of urban/last mile logistics space has forced Retailers to use self storage facilities to store their goods as close as possible to their clients, attracting self storage facilities in the gravitational pull of e-commerce.Many Data Centers REITS took a beating during the last two months, as they were caught in the general pullback of the technology sector. We have spent some time over the last few weeks attending earnings calls of the REITs in our portfolio and have reached the conclusion that things are as good as ever; we feel this is a buying opportunity. Our exposure is currently focused on US Data Center REITs which, despite their US listing, have portfolios spread across the world. Over the last few months, however, we have seen a number of dedicated European Data Center and Digital Infrastructure REITs listing or planning to list on the London Stock ExchangeWe are not rushing in to buy these new players as we want to see how they deploy their IPO proceeds, but the sector is certainly worth monitoring.Similarly, we are studying Asian listed Data Center REITs, as these players have been increasingly buying assets in Europe and USA, and offer an alternative way to gain exposure to the Digital Infrastructure sector.Telecom Towers REITs have also seen their share prices falling over the last few months, despite their business models benefiting from the secular tailwinds of Digital Transformation. We are currently reviewing individually the securities in our buy list to assess if some fundamental change has occurred; if nothing emerges from our analysis, we will probably increase our exposure taking advantage of current price action. Medical Office Buildings and Life Sciences are two sectors we like but are underweighted in our Long Income Fund as it has been difficult to build exposure via Direct Investments or Direct Funds. Specialist REITs in the USA, Canada and UK seems to be the only way to invest in these sectors at the moment, as we get the twin benefit of a relative weak secondary market price as well as access to best in class management teams with healthy acquisitions and development pipelines.Within the Residential sector we will continue to increase our exposure to REITs that provides access to long income strategies like UK Shared Ownership and Social Housing. This is to replace our exposure to UK Residential Ground Rents which we are progressively reducing due to the ongoing regulatory uncertainties.We have however taken advantage of the recent weakness of the Listed German Residential sector to add back exposure in our European Fund.Talking to the leading investment managers active in this sector it has become clear to us that Residential, and in particular the German, Dutch and Nordics markets, have been primed by large institutional investors as the main recipient of the ongoing reallocation of fixed income portfolios, which will provide robust support to valuations for years to come. We continue to monitor the secondary market prices of Listed Infrastructures and Renewable Funds, many of which have been posting negative total returns lately. The secured, long term nature of the assets in their portfolios has driven secondary market valuations to extremely rich levels, making these Funds susceptible to sharp pullbacks as soon as some negative news emerges. We expect a number of these listed Funds to announce capital raises in the next few months to fund their acquisition pipelines, providing us a better re-entry opportunity in the sector.Among the Renewable Funds, we have started to build an exposure to Battery Storage which is a new strategy which can be played either via dedicated funds, or as part of more diversified funds which have recently announced an expansion into this sector. It seems increasingly clear that the lion’s share of the Energy Transformation will be represented by Wind and Solar Energy capacity which require battery storage facilities to store and release the intermittent electricity they produce. As a result, Wind and Solar plants will have to either install battery storage facilities on their premises or lease dedicated space from standalone plants. In particular, we are interested in Funds which enter into long term agreements with credit-worth corporates, an approach which fits better in our long income strategy.Private Real Estate and Infrastructure Funds We are often asked why we have such a large allocation to third party Funds in our own Funds. There are three reasons.Firstly, many of our investors are unable to meet the minimum investment requirements of institutional funds, which start at $1mil but typically are set at $5mil. Via our Funds, which have a much lower minimum investment, our investors can access top tier products on a par with the largest institutional investors, who do not shy away from making indirect investments via these Funds.Secondly, these third party Funds provide us instant access to diversified portfolios of direct investments, which is essential at the early stages of construction of our own portfolio. Whilst we achieve the same diversification via REITs and listed Infrastructure Funds, third party institutional Funds do not expose us to the same volatility risk. Thirdly, and most importantly, these Funds provide us cost savings, as we buy them on the secondary market at a price which is net of the initial stamp duty which we would otherwise pay if we were to buy properties directly. This is an upfront saving of 5-7%, not to mention the savings of other costs (Legal, Tax Advisors) which can easily add up to another 1-2%. These initial savings are often in addition to the currency hedging benefit which, especially for Continental European Funds, generates a net income which almost or completely offsets the additional layer of management fees.We are currently evaluating three secondaries opportunities, all in the UK. The first two Funds invest in Social and Commercial Long Income properties. These funds are experiencing a mismatch of subscriptions and redemptions and offer an opportunity to acquire units at about 5-6% discount to normal subscription price.The third Fund focuses on the traditional UK industrial sector, in particular Airport logistics, which is primed to grow over the next few years as the UK increasingly shifts the composition of its trading partners post BREXIT. Here the opportunity is to buy units at a 5% discount of subscription price, an entry which is effectively equivalent to not paying any stamp duty.Besides secondaries opportunities, we expect during the month of April a capital call from a Global Infrastructure Fund to which we have committed last year and that is working through its acquisition pipeline. Once added to our Long Income Fund portfolio, this Fund will provide increasing exposure to the Data Centers sector, including the exciting sub-sector of Edge Data Centers. Besides Digital Infrastructures, this Fund will give us exposure to long income assets in the Utilities, Renewable Energy and Transportation sectors.Direct and Co-InvestmentsWe are at the final stages of an acquisition of a Tesco Supermarket in Manchester, an asset with in excess of 16 years secure lease to an investment grade tenant and benefiting from 5 yearly, upward only inflation indexations, the first of which in March 2022, is expected to lift rent by more than 10%. The Tesco Supermarket has been made available to investors outside our Fund by way of co-investment as we want to free our liquidity for our next acquisition.UK Supermarkets are currently our favorite hunting ground for direct investments because they enable us to capture secure long income in a sector which has proven resilient not only to the recent pandemic, but also to the digital transformation of the economy associated to the rise of e-commerce.On the contrary, it is becoming increasingly evident that Supermarkets are part of the essential last mile Retail logistics infrastructure, with other essential retailers renting space within the shopping floor of Supermarkets to benefit from continued customer footfall and from the strategic positioning of the assets to support on-line sales.

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