Demolished fund prepares to rebuild

Aberdeen Property Share toppled by more than 38% last year – but Ben Ritchie, manager of the fund, is sanguine about 2008 and says now is a good time to buy shares in the sector.

Aberdeen Property Share featured in almost every newspaper end-of-year round-up as the worst unit trust of the year. It fell 38.8% in the 2007 calender year, the worst of a sorry bunch of property funds that all lost 20% or more of investors’ money over the year.

The fund is run on a team basis, with Ben Ritchie as its principal manager. He confesses there were moments during 2007 in which he was depressed at the turn of events, particularly when the subprime crisis turned a fairly predictable downturn into a massive nosedive. But he’s sanguine about 2008, and for new investors coming in today, sees opportunities to buy at what are incredibly cheap levels.

Investors who lost money through 2007 may feel less enthusiastic. Should Aberdeen have moved the fund more aggressively into cash and other instruments to protect them from the worst of the downturn? Ritchie says no. “We believe in remaining fully invested. We don’t believe we should be running the fund as a hedge fund or as an asset allocator,” he says.

The rout among the equity-based property funds has, of course, been worse than in the physical property funds, and in the short term conditions could remain rough. The wave of redemptions hitting the big physical property funds is forcing them to sell their only liquid asset – property shares – and the constant sell pressure means that the shares could stay low for some time yet.

But this doesn’t alarm Ritchie too much. He compares it with the period 2002-03 when equities were artificially depressed by institutional selling pressure brought on by life company actuaries trying to cover their liabilities. As we know now, early 2003 was a great time to buy equities. Ritchie says property shares may be in a similar environment, and that we may be past the point of maximum bearishness.

He’s buying the sort of smaller property companies that only a year ago were on huge premia but have fallen into deep discounts, largely through fears that they have a development pipeline that may fail to find occupiers.

He likes Quintain, the company developing land around Wembley stadium and the O2 arena. “It is trading at about 420p compared with an NAV of 660p and it probably has another 100p of deferred tax. Its real value could be about 800p a share.”

Quintain’s boss, Adrian Wyatt, told reporters recently that: “Unless there is a sustained contagion from the financial markets, my best guess is that you will not see a sustained bear run in real estate. Come late summer, the worst will be over. It is a time to be cautious, but plan to be bold.”

The other cautious but bold stocks that Ritchie is buying into include Helical Bar, Derwent London and Great Portland Estates. Derwent has a big development pipeline, but it is trading on £12 against an NAV of £19. Its assets are valued at a modest £25 per square foot and it has a well-let portfolio.

Dealings by Derwent’s own directors give a pretty strong clue as to what they think of the share price. In November board directors invested more than £600,000 as the shares tumbled to a two-year low. That perked Derwent back up a bit before they started to fall again to rock-bottom lows.

The others are also bumping along the bottom, but Ritchie is willing to sit it out. “We have seen some forced selling from the physical property fund managers, which has helped to drive down prices. But I am not concerned that there are forced sellers, as I’m quite happy to buy the shares off them at silly prices.”

Aberdeen Property Share may have slid in value more than the physical property funds, but it has never had the liquidity problems they are experiencing. At one point last year its total assets under management were over £700m and today it’s at just £340m. Most of the fall was market related but Ritchie says there have of course been a lot of redemptions. But no one has had to wait for their cash and if necessary Aberdeen could liquidate the entire portfolio tomorrow.

Not that it’s planning to. What it is looking into is whether it’s time to launch an income class to the trust’s units, which are only available as accumulation units.

The yield on the entire portfolio is about 4-4.5%, which is slightly lower than I expected, given the fall in share values but it reflects conservative payout ratios at the developers such as Quintain.

Whether you are brave enough to come back into property shares depends on your view of how nasty economic conditions will be over the coming year. As Ritchie points out, the scale of discount to NAV suggests that investors aren’t just expecting a fall in valuation they also expect occupier problems. But Aberdeen sees that as too pessimistic.

Yes, there may be a softening in demand from City firms hit by the credit crunch, and yes there are lots of pretty pictures of the “Cheesegrater” or the “Shard” to scare investors worried about over-supply. But in reality the picture is much less bleak, he says.

“If all the plans did get built, there would be over-supply. But if you look at what’s broken ground, there’s a lot less supply around than people think.” Surprisingly, the average letting rates in the City are no higher than they were in the early 1990s, and represent a much smaller fraction of total operating costs for City firms than a decade ago.

If you want to be even more gung-ho, then take a look at the housebuilders. They’re among the most unloved stocks in the market at the moment given widespread concern about a crash in the residential market. But Ritchie has just started building a position in Persimmon, which is on a yield of 8.5% and is at a 20% discount to the value of its land bank.

Every year for the past three years Ritchie’s annual report has warned investors that the outperformance of the previous year may not last. At least this year he can be confident that the underperformance of the previous year is unlikely to continue.