This is a very good article on the short history of REITs, the problems experienced by a market that has long been favoured by advisers and an indication that things may not be looking up, but may stop getting worse! The article is from Interactive Investor and can be seen in full here.
There are some important decisions to be made here including:
- Should you still recommend this sector for new money?
- What about existing investments?
- If you use asset allocation tools (more on that in another post) which recommend exposure to this sector, what are you doing?
- Is international property a suitable alternative?
The article is shown below.
The excitement that preceded REIT legislation, introduced in the UK with such fanfare last January, seems now to belong to a different age. In financial markets, oceans of water have passed under the bridge since those days of unbridled optimism.
The central tenet of REITs is that they are not subject to UK tax on property income and gains – those taxes are paid only by the investors in the REIT – so, unsurprisingly, property stocks that were expected to convert to REIT status enjoyed a real boost in the run up to the legislation’s introduction, gaining a full 10% in December 2006. Most major property companies have now converted, taking the total to 18 stocks accounting for some 75% of the sector’s capitalisation.
Almost inevitably, the property market immediately began to struggle. The initial sell-off at the start of 2007 was part profit-taking after the hype and part lack of demand for property at inflated prices. It was followed by blacker months as the credit crunch bit deeper, with the sector ending the year 40% down. In the last quarter, property fund redemption levels were so high that extended redemption periods and Market Value Adjusters have been imposed by funds groups such as Norwich Union, Friends Provident and Foreign & Colonial.
The property sector is now trading at a discount to NAV of 30-40%, compared with around 20-30% historically, and a number of respected players such as Schroder and veteran fund manager Antony Bolton have already called the bottom of the market.
There are some logical reasons for discounts, apart from simple over-selling. A discount reflects at least partially the fact that property company stocks are forward looking vehicles, valued for their future potential, whereas bricks and mortar itself is valued retrospectively. Property stocks should also arguably trade at a premium because the management should be capable of adding value.
Tough to call
Usually, there is fairly good consensus at any given time about prospects for various property sectors, but this time the picture is difficult to fathom and opinion about sectors is divided.
Most of the problems have their origins in the credit squeeze. Office space in Canary Wharf and Docklands will be vulnerable if big City firms continue to lay off staff, but the recent downsizing is largely limited to the investment bank giants whose debt teams are mostly housed in the US. The same generalisations cannot be made of Mayfair and St James’s, the territory often associated with hedge fund offices, partly because hedge funds tend to rent small square footage.
The credit squeeze has also hit Christmas trading, but although retailing looks set to suffer the new patterns in consumer behaviour are not clear. While this Christmas was a record year for internet, no-one is sure how much of that was down to cold snap two weeks before the festivities and how much is wholesale broadband take-up, a one-off gear-change that is unlikely to be repeated on the same scale next year.
Heading out of town
Out of town shopping centres seem more protected, as they cater for the hardened shopper for whom a retail trip is a regular hobby and they also tend to have a better quality of tenant. Liberty International (LII) has a portfolio of top quality retail properties that include Lakeside and MetroCentre and focuses on out of town outlets so could be less vulnerable to a downturn.
“The risk is how much the market overcorrects,” says Duncan Owen, CEO of Invista Real Estate Investment Management Holdings (INRE), who anticipates high single digit returns over the next three years. “If anything, commentators are being too bearish about the City and too bullish about the West End, where some tenants are locked into over-renting for the first time in 17-18 years.”
But John Burns, CEO of design-led Derwent London (DLN), says that on the contrary he has re-let a property in Fitzrovia at £60 per sq ft compared with the £57.50 it went for in June. “The key here is the availability of space in the West End with its strict planning regime,” argues Burns.
Derwent specialises in design innovation, taking derelict warehouses and unloved office blocks and transforming them state of the art landmarks just outside the West End and the City in areas such as Fitzrovia and Islington. For instance, it bought The Tea Building in Shoreditch for £22 million in 2000 and gave it a £6 million makeover, nearly tripling it value.
Boost for warehousing?
Less debatably, sustained growth in internet shopping would boost industrial warehousing. Industrial warehouse developer Brixton (BXTN) has spent January buying the assets of redemption-hit funds such as New Star at a discount.
Brixton is also a frontrunner in a joint venture with warehouse specialist Prologis to buy the BAA’s Airport Property Partnership from owners Ferrovial and Morley Fund Management.
Discount buying has also been the order of the day at Rugby Estates (RES), which has just acquired three highly diverse portfolios at a reasonable price. While most property companies specialise in a sector, Rugby Estates, floated last April, focuses on picking up family portfolios with a wide spread of properties by both size and use, which its peers have no taste for.
Such properties are often well located on recession-resilient primary sites with a broad tenant spread. For example, one recent £180 million deal bought with it 100 tenants so one tenant failure would have little impact on the portfolio’s overall returns.
Andrew Wilson, chief executive, reckons that £50 billion of private property companies exists in the UK. “It is staggering to us how many second or third generation property companies have had a conversation with us,” he says. “We’d never heard of many of them.”
In the US, residential property REITs are the most popular sector. The UK property industry is working on overcoming the remaining barriers to these, according to Dave Butler, programme co-ordinator at REITA, so now might be the time to tuck away a residential specialist such as Grainger (GRI).
