Principal risks and uncertainties
The Managing Trustee has overall responsibility for risk management and internal controls for the Fund.
The principal risks and uncertainties of the Tritax Property Income Fund (TPIF or the Fund) are set out below. They have the potential to materially affect the business of the Fund, either favourably or unfavourably. Some risks may currently be unknown, while others that we currently regard as immaterial, and have therefore not been included here, may turn out to be material in the future.
Tenants may default
Probability: low to moderate
The default of one or more tenants would immediately reduce revenue from the relevant asset(s). If the tenant cannot remedy the default and needs to be evicted, there may be a continuing reduction in revenues until a suitable replacement tenant is found. Any default may impact the capital value of the asset adversely. Worsening economic conditions including higher inflation could place greater pressure on tenants in the coming year, increasing the risk of default.
This risk is mitigated through the implementation and review of the Fund’s investment policy and restrictions which limit the exposure to any one tenant to 25% of GAV, or 40% where such a tenant is listed in the FTSE 350, although in practice the level of diversification and therefore risk mitigation is much greater than this. Before investing, the Fund’s Investment Committee undertake thorough due diligence, particularly over the strength of the underlying covenant. Assets are selected with strong property fundamentals (good location, modern design, sound fabric), which should be attractive to other tenants if the current tenant fails. The average credit score of tenants in the portfolio has improved over the past year.
The value of the property portfolio may fluctuate
Property and property related assets are inherently difficult to value due to the individual nature of each property. The Fund outsources the valuation of its properties to an independent firm of chartered surveyors who are experienced in valuing property assets similar to those owned by the Fund. Property values grew strongly in 2021, with reductions in yields and rental growth, values fell significantly in 2022 under worsening economic and market conditions. Valuations appear to have stabilised in the first half of 2023, so this risk appears to have reduced, although there is the risk of further economic shocks.
Impact: low to moderate
An adverse change in property valuations may lead to a breach of the Fund’s banking covenants. Where assets need to be sold in a short timescale to fund redemptions, the value realised may be lower than the carrying value, this in turn may lead to a further fall in NAV.
The Fund’s investment restrictions restrict investment in any one asset to a maximum of 20% of the GAV of the Fund. They also restrict maximum exposure to any tenant or developer to 25% of GAV, other than tenants who are within the FTSE 350 where the maximum exposure is limited to 40% of GAV at the time of the investment, although in practice the level of diversification, and therefore risk mitigation, in the Fund is much greater than this. The property portfolio has an average unexpired weighted average lease terms of approximately nine years. All the leases contain upward-only rent reviews, which are either fixed, RPI/CPI linked or at open market value. These factors help maintain the value of the Fund’s assets.
Portfolio growth may slow
Probability: moderate to high
The ability to grow the portfolio may be affected by the state of the UK commercial real estate market and competition for investment properties. The UK commercial real estate market remains highly competitive within certain specific sectors, particularly those in which the Fund is invested, with a weight of funds pursuing opportunities, which make it challenging for the Fund to secure assets that meet the investment strategy of the fund. The investment strategy is mainly focused on long, secure income in the favoured sectors of logistics, industrial and retail warehouse assets.
Impact: moderate to high
The impact of this risk is moderate to high, as competitors in the sector may be better placed to secure property acquisitions, thereby restricting the Fund’s ability to grow its portfolio.
This risk is mitigated by the extensive contacts that the Trust Adviser has in the sector which allow the Fund to benefit from off market transactions. The Trust Adviser also maintains close relationships with investors and developers in the sector, giving the Fund the best possible opportunity to secure future acquisitions. The Fund is not exclusively reliant on acquisitions to grow the portfolio. The leases contain upward-only rent review clauses and there are many current asset management initiatives within the portfolio, which means additional income and value can be generated from the existing portfolio. The Trust Advisor is disciplined in its investment of capital and will not pay a price which it believes is above market value just to secure a purchase.
Liquidity for the Fund’s commitments may not always be available
Rapid increases in values of units in the fund in 2021 and the first half of 2022, coupled with reductions in other asset classes has put pressure on the asset allocators in our investors to reduce their real estate holdings to rebalance their portfolios. This has led to redemption requests from investors for in excess of a third of the units in the fund. The probability of the Fund having insufficient liquidity to meet internal operational commitments and external redemption requests is therefore high, as it seeks to make disposals to fund these redemptions.
Liquidity pressures from redemptions managed through the sale of assets could lead to a further reduction in the value of such assets at disposal, depending on market conditions.
The Fund actively monitors its short and medium-term liquidity. The use of suspension, deferral of redemptions, drawing of debt and anti-dilution levies would minimise the impact on the Fund’s performance. The Fund suspended redemptions in September 2022. The fund has also been able to dispose of non-core assets to meet the majority of the current redemptions.
Inflation in the UK may increase from current low levels
Probability: moderate to high
Inflation in the UK has increased to significantly above the recent historic range of 1-2%. In the past two years, a combination of economic, political and international events have disrupted trade and started a move to higher inflation which could be sustained in the medium term with the prospect of weaker economic conditions and possibly recession.
Impact: moderate to high
Higher inflation could result in higher costs to the Fund. Where rents are subject to RPI/CPI increases, excessive increases could make the rental levels unaffordable for tenants, if they are unable to pass the higher costs on. Although inflation may be positive for the Fund in some respects, such as potentially greater demand from investors for investments perceived as a hedge against inflation, a weakening economic climate will not benefit the Fund in finding, securing and maintaining financially robust tenants.
Higher inflation would lead to greater rental growth and so greater returns to investors, subject to the ability of tenants to pay the higher rent. Costs of the fund which are subject to inflation are relatively small.
Interest rates may fluctuate
Probability: moderate to high
Interest rates have risen significantly over the past year, and this has a moderate impact on the Fund’s operations.
Interest on the Fund’s debt facilities is payable based on a margin over a market-standard risk-free rate. Any adverse movements in that risk-free rate could impair profitability. Medium term interest rates have increased dramatically in the past few months.
The Fund has entered into interest rate derivatives to hedge its direct exposure to movements in interest rates. These derivatives limit the exposure to the level at which interest rates can rise and have terms coterminous with the loans. Under the terms the debt facilities, the Fund is required to minimise the level of unhedged debt, by taking out hedging instruments with a view to keeping variable rate debt in excess of 70% hedged. The debt is fully hedged until November 2024.
Debt funding at appropriate rates may not be available
The probability that availability of debt will impede the Fund’s ability to refinance by November 2024 is moderate, given higher interest rates reduce the ability of debt to be accretive to the performance of the fund.
The lack of debt funding may hinder the Fund’s ability to pursue suitable investment opportunities in line with our investment objectives. If the Fund cannot source debt funding at appropriate rates, either to increase the level of debt or refinance existing debt, then this may impair the Fund’s ability to grow. Indeed, if debt is not expected to be accretive in the longer term, the fund may seek to sell assets to reduce or even eliminate debt in the fund.
The investment restrictions set out in the Unit Trust Instrument restrict the amount of debt to a maximum of 25% of GAV. Therefore, the reliance on debt funding to secure the purchase of assets and to maintain the target level of distribution is low. The Fund engages in discussions with existing or potential lenders to assess the availability of debt and the terms on which such debt can be secured.
Banking covenants may be breached
Probability: low to moderate
The probability of the Fund not being able to operate within its banking covenants is low to moderate, as recent reductions in value have placed slightly greater pressure on the loan to value covenant.
If the Fund is unable to operate within its banking covenants, this could lead to default and the bank funding being recalled. This may result in the need to sell assets in order to repay loan commitments.
The Fund monitors its banking covenant compliance, to ensure there is sufficient headroom and to give an early warning of any issues that may arise. The level of gearing permitted under the Fund’s investment strategy is low. The diversified nature of the investment portfolio also reduces the likelihood of defaulting on banking covenants.
The Fund is reliant on the continuance of services provided by the Trust Adviser
The Fund continues to rely on the Trust Adviser’s services and their reputation in the property market. As a result, the Fund’s performance will, to a large extent, depend on the continued provision of these services. Termination of the Trust Adviser and Partnership Management Agreements would severely affect the ability of the Fund to effectively manage its operations and may have a negative impact on the ability of the Fund to secure further assets.
The Trust Adviser is incentivised by its fee arrangements to maintain its relationship with the Fund. Further, the Fund is branded as a “Tritax” product thereby ensuring that the Trust Adviser is unlikely to terminate the relationship. Unless there is a default, the agreements can only be terminated providing that an extraordinary resolution to provide for termination is approved by 75% of the Unitholders.
The Fund is reliant on the performance of outsourced service providers, such as the administrator
In respect of the administrator, the Fund relies on the administrator for accounting transactions, monthly reporting, tax compliance and communication with investors. Poor performance of the administrator can reflect badly on the Fund and may even cause financial loss.
The Fund contracts with the administrator so the relative responsibilities are made clear. In addition, a service level agreement sets out the delivery and timing expectations of all key tasks. The Trust Advisor maintains regular contact with the administrator and reviews all aspects of their work, particularly outputs such as unit price reporting.
A change to the Fund’s tax status could affect its returns to Unitholders
Any change to the tax legislation that reduces the tax efficiency of the Fund may reduce the financial returns that Unitholders will receive. The fund structure uses Scottish and English limited partnerships to deliver tax-efficient returns to a Jersey Unit Trust to manage taxation on income and capital gains generated by the operations of Fund. The use of such an investment structure is commonplace in the UK commercial real estate market, and the impact of changes in tax legislation that threaten the efficiency of the structure currently employed would have widespread implications for the market.
HMRC has enacted legislation on non-resident companies’ chargeable income tax and non-resident capital gains tax. The Trustee has made an exemption election owing to the predominantly exempt nature of the Unit Trust’s investors, so that the exempt Unitholders in the Fund are unaffected by the changes in legislation. Both resident and non-resident investors in the Fund are within the charge to UK tax in respect of any gains realised on disposals or redemptions of their units, subject to the availability of any applicable exemptions or reliefs.
Political and economic risk
Political and/or economic uncertainty may arise from external events
Probability: moderate to high
The Fund operates with a sole focus in the UK. Any resultant downturn in the economy of the UK could lead to higher levels of tenant default and reduced asset values. The UK economy is, however, inextricably linked to the global economy, which has suffered a series of significant shocks over the past few years, from the various lockdowns throughout the world, to the war in the Ukraine disrupting global trade, shortages of raw materials and higher energy prices, which in turn has led to global inflation which central banks are now seeking to control. In the UK this has been exacerbated by the implications of the exit from the European Union.
Lower international demand for UK commercial real estate assets may also reduce asset values.
The investment strategy of the Fund seeks to mitigate exposure to geographical and tenant covenant risk, with restrictions on the proportion of GAV that can be invested in single assets or single tenants.
Environmental issues may cause loss to the Fund
There are several ESG risks potentially impacting the Fund and its tenants, notably environmental issues such as climate change and biodiversity risks. The ESG credentials of the assets of the Fund may no longer meet the needs of the tenants, requiring change at a cost to the Fund. The Fund may not meet its ESG targets causing potential reputational or financial loss to the Fund.
The Trust Advisor has a senior staff member dedicated to ESG matters who has been instrumental in setting an ESG strategy for the Fund, which addresses all the key ESG risks, and seeks to improve the reporting and control over such matters. The Trust Advisor also provides training to all staff on ESG matters to ensure consideration is given to ESG at all stages of the investment process.