Principal Risks and Uncertainties
The Managing Trustee has overall responsibility for risk management and internal controls for the Fund.
1. Tenants may default
The probability of the default of one or more tenants
is moderate. This risk crystallised in March 2020 as some tenants took advantage of the Government’s limited moratorium on lease forfeiture for non-payment of rent, particularly in the retail sector. By June 2020, however, the position had stabilised with retail units re-opening to the public, and tenants starting to agree rent deferral plans.
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, which may affect the Fund’s distributions to Unitholders. The crystallisation of this risk at March 2020 did not lead to any material provision being made.
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. To further mitigate geographical shifts in tenants’ focus, the Fund invests in assets in a range of locations, where it is believed demand for the type of asset acquired will remain robust. Before investing, the 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.
2. 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. Indeed, the Fund’s valuers have expressed material uncertainty in their valuation as at 31 March 2020 in view of the COVID-19 pandemic.
Impact: low to moderate
An adverse change in our 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 Investment Restrictions limit 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 development 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 11.6 years. The portfolio has been constructed to comprise a range of asset types, in different geographical locations with a wide range of tenant covenants, all of which will reduce the risk of a substantial fall in the value of the portfolio. 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.
3. Portfolio growth may slow
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, 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.
This investment demand is mainly focused on long, secure income in the favoured sectors of logistics and alternative assets. Indeed, the market was severely restricted by the reaction to the COVID-19 pandemic in early summer 2020, although we may see buying opportunities later in the year.
Impact: moderate to high
The impact of this is moderate to high, as competitors in the sector may be better placed to access property acquisitions, thereby restricting the Fund’s ability to grow its NAV.
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 without overpaying. 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. There are a number of current asset management initiatives within the portfolio, which means additional income and value can be generated from the existing portfolio.
4. Development activities may not be profitable
Development activities are likely to involve a higher degree of risk than is associated with standing assets. The probability of this risk is low.
Developments undertaken by the Fund are likely to involve a higher degree of risk than is associated with standing investments. This could include general construction risks, delays in the development or the development not being completed, cost overruns or developer/contractor default. If any of the risks associated with developments materialised, this could reduce the value of these assets and the Fund’s portfolio.
The investment strategy only permits a maximum exposure to development arrangements of 30% of GAV, although in practice the amount of development currently undertaken is less than 10% of GAV. The Fund engages skilled and experienced specialist professionals to undertake all aspects of development. Capital for developments remains under the control of the Fund and is only released to the developer on a controlled basis subject to milestones as assessed by independent project monitoring surveyors.
5. Interest rates may fluctuate
The probability of this risk is low, particularly as the current economic conditions are likely to keep interest rates low.
Interest on the Fund’s debt facilities is payable is based on a margin over LIBOR. Any adverse movements in LIBOR could impair our profitability and ability to pay distributions to Unitholders.
The Fund has entered into interest rate derivatives to hedge its direct exposure to movements in LIBOR. These derivatives cap the exposure to the level at which LIBOR can rise and have terms coterminous with the loans. Under the terms of the debt facilities, the Fund is required to minimise the level of unhedged debt with LIBOR exposure, by taking out hedging instruments with a view to keeping variable rate debt in excess of 70% hedged. At the year end, the Fund’s facilities were 90% hedged.
6. Debt funding at appropriate rates may not be available
The probability that availability of debt will impede the Fund’s ability to grow is low.
The lack of debt funding may hinder the Fund’s ability to pursue suitable investment opportunities in line with the 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 maintain its targeted level of distribution.
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.
7. Banking covenants may be breached
The probability of the Fund not being able to operate within its banking covenants is low, given the low level of debt in the Fund.
If the Fund is unable to operate within its banking covenants, this could
lead to default and the bank funding being recalled. If the debt cannot be refinanced, it would 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 Investment Strategy is low, with the use of interest rate caps mitigating the risk of interest rate rises. The diversified nature of the investment portfolio also reduce the likelihood of defaulting on banking covenants.
8. The Fund is reliant on the continuance of services provided by the Trust Adviser
The risk of losing the services of the Trust Adviser is low.
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 Agreement 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 maintain its targeted level of distribution.
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 aligning the reputation of the Trust Adviser with the performance of the Fund. Unless there is a default, the agreements can only be terminated
if an extraordinary resolution to provide for termination is approved by 75% of the Unitholders.
9. A change to the Fund’s tax status could affect returns to Unitholders
The probability of such a change is currently low, as given a recent change in law, it is unlikely that any further material changes will be forthcoming in the short to medium term.
Impact: moderate to high
The Fund structure uses Scottish and English limited partnerships under a Jersey Unit Trust parent to provide tax transparency to investors. Any change to the tax legislation that reduces the tax efficiency of the Fund may reduce the net of tax financial returns that Unitholders receive.
The use of such an investment structure is commonplace in the UK real estate fund 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 have enacted legislation in respect of non-resident companies’ chargeable income tax and non-resident Capital Gains Tax. The Managing Trustee made an exemption election regarding the tax status of the Unit Trust during 2019. As a result, the exempt Unitholders
in the Fund should be unaffected by the changes in legislation owing to their exempt status. Both resident and non-resident investors in the Fund will be 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.
10. Political and/or economic uncertainty may arise following the UK’s exit from the EU
The probability of this risk is moderate.
Impact: moderate to high
Economic volatility is not a new risk for the Fund; however, until the terms of the ending of the transition period on 31 December 2020 become clearer the exact impact on the Fund is difficult to predict.
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. It may also reduce asset values due to lower international demand for UK commercial real estate assets.
The Investment Strategy of the Fund seeks to mitigate exposure to geographical, sectoral and tenant covenant risk, with restrictions on the proportion of GAV that can be invested in single assets or single tenants.
11. Liquidity for the Fund’s commitments may not always be available
The probability of the Fund having insufficient liquidity to meet internal operational commitments and external redemption requests is low, given the level of the Fund’s existing commitments, and its available committed equity and debt.
The Fund has equity commitments and debt commitments which remain undrawn. Redemptions above the level of available net commitments would need to be met through raising additional debt or sale of assets, which could have a negative impact on the distribution.
The Fund actively monitors its short- and medium-term liquidity. The use of suspension of the Fund, deferral of redemptions or drawing of debt would minimise the impact on the Fund’s distribution.