In this weekly series, investment reporter Elliot Gulliver-Needham sits down with a fund manager for a Q&A. This week, we’re hearing from Nick Montgomery, manager of Schroder REIT.
How does your fund stand out from others in the same market?
Whilst the whole sector has been impacted by the higher rate backdrop, which has weighed on sentiment, there are now signs that values have stabilised, and Schroder REIT is very well placed to benefit as investors look to increase their exposure to the sector. Importantly, whilst the recent market valuation decline of 25 per cent is significant even from a historic perspective, rental values are increasing in response to inflation and a restricted development pipeline, which is in stark contrast to past downturns.
Our shareholders benefit from the highest, fully covered dividend amongst the immediate peer group, reflecting the portfolio’s income characteristics and low-cost, long-term debt profile. As well as benefiting from a higher income yield compared, the funds independent valuer currently estimates a 30 per cent upside in the portfolio rents, providing potential for future earnings growth, especially when combined with our active management.
Leveraging the £26.5bn Schroders Capital real estate platform, at the end of last year we became the first investment trust to put sustainability at the centre of its investment strategy, which we expect to further drive future performance. Given the increasing focus of occupiers on sustainability credentials when signing leases, we believe our more focussed approach to incorporating sustainability initiatives within asset repositioning activities will allow us to build on the long-term outperformance of our underlying portfolio.
Which of your assets are you most excited about?
Stanley Green Trading Estate in Manchester, where we have delivered the region’s first operationally net zero carbon industrial scheme on surplus brownfield land, and which provides 80,000 square feet of best-in-class warehouse and trade counter space. It’s just one example within the portfolio where sustainability improvements have been delivered through active asset management.
The specification includes a photovoltaic system that we expect to generate more than 250 MWh of energy per annum, 24 electric vehicle charging points and an 800kVA substation to support the on-site renewables in powering the fully electric site. The asset has been one of our strongest performers – we recently let a unit on the existing estate with EPC C at £14.00 per sq ft, whereas the comparable operationally Net Zero Carbon units with EPC A+ was let at £19.50 per sq ft, a 39 per cent premium.
What is the biggest mistake you’ve ever made in the fund?
Less a mistake, but due to unfortunate timing of a historic debt financing, prior to 2019 the fund had a higher debt cost versus peers. This higher interest cost acted as an anchor dragging returns. With support from shareholders, we therefore made the difficult decision to refinance this loan and, in return for a one-off payment equating to seven per cent of NAV, we rebased the fixed interest rate from 4.4 per cent to 2.5 per cent per annum. We are now benefiting from the lower debt cost, with the interest saving passed to shareholders as increased dividends.
What’s one change you made in the fund recently?
There is a significant ‘Green Premium’ for the right assets in the UK, with both occupiers and investors prepared to pay more for energy-efficient buildings. As most of today’s commercial real estate stock will likely still be required and in use in 2050, it is only by transforming less sustainable buildings into modern, fit for purpose assets that the sector will reach the UK’s Net Zero Carbon objectives, and asset obsolescence resulting from enhanced regulations can be mitigated.
Recognising the above, last year we became the first investment trust to commence a process to formally place sustainability at the centre of our real estate investment proposition and received strong shareholder support in December 2023.
A proprietary and independently validated scorecard methodology for monitoring and reporting on environmental performance allows investors to monitor the portfolio’s progress against clear, asset-specific sustainability targets and gives the portfolio managers the opportunity to lead the way on sustainability. To date, 15 assets now have an ESG scorecard completed by an external consultant along with a sustainability audit or net zero carbon audit.
What’s the biggest change you’ve seen in the industry since you started?
Accelerated economic and social megatrends, accelerated by the pandemic, mean real estate investment today requires a more innovative approach and hospitality mind-set when it comes to sourcing and managing assets across all sectors. Alongside a broader range of amenities and services, many of our occupiers require more flexibility, with average lease lengths roughly halving across the whole market since 2008.
We therefore manage each asset as a business itself, to ensure that the services provided and contract terms offered meet changing tenant demands, and that assets are operated efficiently to minimise the use of scarce resources, waste and carbon emissions.