Interesting report out yesterday form the real estate analysts’ team at Morgan Stanley. Entitled Taking Stock it asks the question many of us are asking – is now the time with deep discounts to jump back into real estate funds? Or, to put it another way, are the deep discounts signalling bargain basement??

The report’s authors are cautious but I think we can probably guess that the short answer in the next few months at least is no – although a stronger argument can be made for the longer term for a value entry point. The analysts are “reducing price targets on average by 13% and … lowering 2020 and 2021 NAVs per share on average by 7% and 10%, respectively.” The key driver is obvious – Covid 19 is driving a “reduced willingness and ability to pay retail rent (lower aggregate retail sales medium term, reduced mall footfall, more online), and could see a positive step change for logistics (near term more inventory build up, medium term more online retail sales, more on-shoring and perhaps a move away from Just In Time management).

Sensibly the Morgan Stanley analysts reckon that any demand change in office demand will play out slowly – “ demand for large corporate HQs could reduce but this could be
partly offset by a reversal in densification – we think that for the next couple of
years at least, office trends will be driven mainly by economic growth rather than
these potential structural pressures”.

So, back to my question – are we there yet in terms of share prices? In the short to medium term the challenge is that reported NAVs haven’t really fallen yet with Q2 transaction activity virtually non-existent. “Medium term, it would be rare to see such a deep recession without some material NAV decline”, they sensibly suggest.

But over the longer term prices might be moving towards a low, especially as the wider the NAV discount, “the higher the future returns and this is particularly relevant on a five-year view, and/or when discounts are very extreme (i.e. >40%). At today’s mid-30’s discount, historically total share price returns have averaged +14%, +31% and +99%, on a 1, 2 and 5-year view; but we note, excluding retail, the discount is in the 20’s, which suggests returns only slightly above historical averages.”

The chart below nicely sums up this analysis.

For the record, because I think in the second wave of crisis – with much more danger to come – I’m still bearish on the sector and think that there’s a lot more pain to come.

That said, I also think that a few specific property funds are trading closer to a sensible price at which we could perhaps buy back in even at this early stage in the multiple crises.

Take Phoenix Spree Deutschland Limited (LSE: PSDL.LN), for example, the UK listed investment company specialising in German residential real estate, which has just released a COVID-19 update. This was already trading at a big discount after the shock decision by the Berlin government to introduce new rent controls. And then along came the virus and discount widened out again.

On paper though Phoenix Spree might actually be in a decent spot moving forward. Germany looks to be in decent situation, having sensibly managed the Covid crisis – although it is of course early days. Crucially the fund reports that “To date, the impact on rent collection has been limited. In the month to 30 April 2020, 98% of rent due had been collected in total compared to 99% in January 2020. Residential rent collection has remained particularly resilient, with over 99% of rent collected during the month of April. Germany’s Hartz IV welfare programme includes help for rental payments in instances of financial hardship and is available to tenants impacted by the COVID-19 outbreak”.

The fund also a much, much smaller portfolio of commercial properties (1o% of the portfolio) and these have obviously been hit by the lockdown but the fund reports that during “the month of April 2020, 89% of commercial rents have been collected, compared with 96% in January 2020.” The update also contained details of a successful refinancing of a loan and also observed that when it comes to the new rent control regulations, on the “6 May 2020, the parliamentary groups of the CDU/CSU and FDP of the Deutsche Bundestag officially filed for a judicial review of the… legislation at the federal constitutional court in Karlsruhe.”

More Fund survivors

Sticking with this notion of investing in funds where the Covid crisis hasn’t massively impaired cashflows, its also worth noting Q1 numbers from private equity fund HgCapital.

Many of the heavy weight private equity giants have been reporting declines of 10% or more, but Hg reckons their NAV declined by 6.2% over the quarter.

“The portfolio valuation fell 7% over the quarter, and within this lower market multiples drove an 11% decline, partially offset by 5% appreciation from the trading performance of the underlying portfolio companies. Adjusting for FX and costs since the quarter-end results in an estimated NAV of 238p, reflecting a 7.6% discount”.

£134m was invested during the quarter, against only £3m realised, according to Jefferies funds’ analyst Matt Hose. “The little changed EV/EBITDA multiple of 19.6x at 31/03/20 amidst the 1.5x like-for-like de-rating infers that the recent investments (Argus, Intelerad, smartTrade, and P&I) entered the portfolio at somewhere around a 20x multiple”.

Portfolio liquidity was £100m (after the May dividend), with the £80m bank facility now fully drawn.

Liberum’s analysts conclude thus : “HGT’s portfolio valuation has been less severely impacted by the ongoing Covid-19 pandemic due to its 100% focus on technology companies…..Based on net debt of £52.8m, we calculate an implied look-through leverage of 29.3% for the company….HGT’s commitment coverage ratio is the lowest in the peer group at c.10%. However, the company benefits from having the ability to opt out of any new investments without penalty, should it not have the cash available to invest.

Hg Capital trade’s at a near 10% discount and yields 2.3%.