I first invested in the UK REIT sector (though it wasn't called that then!) in 2003 via Tr Property . For anyone that wants exposure to the UK propery sector I can recommend this trust as a well managed and diversified vehicle for doing so. I also recommend studying their recent full-year and interim reports, which I find rather insightful - and don't pull any punches, even at the expense of deterring potential investors!

I exited most of that investment by early 2007, and finally exited completely early this year, after a strong rebound from the lows. In 2007 I performed this analysis , reaching the conclusion that the sector wasn't cheap. With all the market turmoil, I hadn't rerun the analysis, as the underlying figures were subject to so much uncertainty.

Now that we have seen some recovery in the sector and reported stabilisation of property values, I thought it would be an opportune time to re-run the analysis and see whether value was available. So, I post below my current calculations and then my conclusions based on those. I have chosen 3 of the largest REITs to analyse:

I have done my best to compare "like-with-like" but must warn that I may have missed "special factors" that may make the comparison unfair. Hence I would advise readers to perform their own analysis/checks and not to rely too much on my calculations. OTOH, the ratios and the trends seem reasonably consistent between the companies which suggests to me that I'm not too wide of the mark.

The Figures

 

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About the Author

Marben100

Premium Member

I am a full-time private investor... with a little trading on the side (generally small-scale arbitrage in specialist niches). Previously, I spent 24 years in the IT industry, 13 of those running my own IT services firm. I invested as a "hobby" for 20 years before turning it into a full-time occupation in 2004. I really enjoy the "research" side of investing, finding out about varied businesses and industries and learning what makes them tick. Since going "full-time" I have learnt an awful lot from some very erudite investors & professionals who are kind enough to share their expertise in electronc forums such as this. I can now count a number of them as my friends, having had the opportunity to meet them in the real world, as well as this virtual one! I try to pay back the debt I owe by sharing what I've learnt and I always value constructive criticism to correct my errors and misapprehensions! I am a Director of ShareSoc, the UK organisation for individual shareholders. See below for details.     more »

4 comments

Stockhound

Excellent thread! Reference the discussion about interlinking articles and forums, I am just flagging this related article - http://www.stockopedia.com/article/view/31815/commercial-property-have-you-missed-the-boat

Reply
marben100

I have now updated Land Securities Group Plc 's figures in the header to include the interim results published earlier this week and they look rather better than the others, to me.

Crucially, equity stands at 57.9%, which allows for some leeway in the event of a further downturn in property values. The rental: market cap metric, which takes the effect of gearing & interest into account, is quite decent at 6.2%. However, ungeared rental remains at 5%, which seems OK  but far from exciting. The company says:

 

  • Business positioned in short term to exploit medium-term opportunities

With a belief that West End offices will deliver strong rental growth in the recovery phase, construction tender returns have been sought on 60,000 sq m of office, retail and residential development opportunities in the West End. The schemes at Park House, W1, Selborne House, SW1, and Wellington House, SW1, can be started in 2010 for delivery into improving occupier markets in 2012 and 2013.  

I am much less sanguine than they are that rents in that timeframe will be higher than they are now (barring the effects of inflation).

Cheers,

Mark

Reply
marben100

Tr Property 's interim results are out today. As usual their property market commentary makes for interesting reading:

Property Investment Markets

 This dash for higher, and therefore riskier, income has had a dramatic impact on the pricing of all high yielding assets over the half year. Corporate bonds and equities led the way, but since the late summer physical property has come to the party. The obvious weakness of the rental demand and the shortage of credit have clearly been delaying factors, but there is now, in the UK, a considerable quantity of cash lined up and actively seeking investments, and, very importantly, a dearth of decent quality property for sale. Distressed selling from property companies and institutions has almost totally dried up - indeed many have turned buyers again. Very importantly the banks, as discussed in the next paragraph, are showing no present urgency in sorting out their loan books. There is virtually a frenzy in the market, as there has been in some areas for housing. Yields for the most desirable properties, which still means buildings let on long leases at sensible rents to household names, have jumped downward by as much as 200 basis points since April to below, sometimes well below, 6%. Buyers have reacted by moving up the risk curve to accept shorter leases and less secure tenants so that good secondary investments, which were totally unwanted in the Spring are now being hunted down and selling for above asking prices. 

 Buyers and potential buyers in the UK property investment industry are split into two distinct camps; those who believe that today's prices represent good value relative to returns from other high yielding asset classes, and those who consider the current market to be just a mini-bubble inflated by artificially low interest rates and by the lack of freely available property stock. This latter camp generally believe that an anaemic economic recovery will mean that rental values continue to decline through 2010, eating into the long term income returns from real estate, and that the best policy is to wait until the banks and their clients are forced to de-gear and expose a lot more stock onto the market. Forward pricing in the IPD Index derivative market is siding with the cautious and indicating only 1% to 2% capital value growth for the average UK commercial property in 2010. 

 On the Continent property values have generally been marked down by 10 to 15% less than in the UK, and therefore there is less evidence of a sudden rush to buy. Nevertheless the investment volumes have increased in most locations. As in the UK good quality property appears to be in rising demand, though, again, there is little available on the markets.

 

Rental Values 

 Rental values have continued to decline across the UK and Europe though the pace is varying by property type and location. As we commented in May the widespread use of rent free periods and other incentives may be masking the true position. The IPD index in the UK suggests that rental values fell 3.4% over the half year to end September but this decline is based on headline rents not effective rents. The worst declines have come in capital city office markets - London, Paris and Madrid etc where falls of 30% or more are now documented. Encouragingly such falls have now started to stimulate demand, at least at the gross level, as occupiers take advantage of bargain rents to reorganise and improve their workspace. With no new developments started for some two years, a shortage of brand new space may be seen in 2010. Suburban and regional office markets have been very mixed and statistically have suffered less than city centres, but the truth is often that demand is so patchy that lowering asking rent will not yet hasten a letting. Industrial and storage space is also a very weak market particularly in the UK where the nationwide vacancy rate is now above 15%. The retail picture is very mixed. Demand has held up very well in Central London where tourism has given turnover a strong boost. On the Continent retail rental values appear to have been resilient, with the notable exception of Spain...  

 

...Big companies underperformed. The ten largest companies in the benchmark at the end of March made up 60% of the benchmark by weight. Of these ten, only Klépierre rose by over 100%, Corio and Hammerson rose over 50%, and all the remainder underperformed with Liberty International, PSP Swiss and Wereldhave all rising by under 30% and Unibail, itself 20% of the benchmark, rising only 33%. 

This leap in share prices has not been accompanied by a surge in net asset values, earnings or dividends. The rerating of the sector has merely brought share prices closer in touch with asset values in response to the belief that capital values have stabilised and will start to grow modestly (in the UK) and are about to stabilise (on the Continent). In the UK most share prices have now moved to the last stated NAV or to a premium to that number. On the Continent discounts have narrowed sharply but are still generally available.

Corporate activity has been muted. In the only deal worth over £100m Segro acquired Brixton through an all share offer and then had a second rights issue to repay some of Brixton's debt.  

Dividend passes or re-positionings (a smarter word for "cuts") have continued to be seen particularly when accompanied by a rights issue. Revenue earnings are under pressure, more so in the UK than in the rest of Europe. Rental income growth is non-existent everywhere, save from letting void space, but most Continental companies have exposure to some variable rate short term debt and are benefiting from lower interest costs, while the vast majority of UK property company debt is fixed directly or via swaps. 

As noted in the Introduction, rights issues and other capital raisings have been commonplace, and there are now very few highly leveraged quoted companies who have not tapped the market for fresh capital. Underwriting fees have been generous and the exercise, particularly for those who raised capital before midsummer, has been hugely dilutive to those shareholders who could not participate. Since July a number of issues, including three new issues, have been made to fund the acquisition of distressed property. It is clear now that this capital may not be easy to spend sensibly in the short term. 

 

It seems that TR's investment managers share my cautious views on the sector.

Regards,

Mark

Reply
valueinvestor

A really super thread - impressive number crunching. I know talking to chartered surveyors earlier this year, many of them were expecting 10-20% declines in rents- so that was to some extent already in the share price. Equally, this year has seen fewer and fewer development completions, and 2010 will see practically no developments at all coming on stream in markets such as Birmingham and Cardiff - a number have been mothballed. So there is a supply side crunch that ought to help the market - though you are right about the demand side being very flat.

But I think TR Property's observation about funds chasing high yields is correct. We've had a good run this year and I certainly wouldn't buy at today's price. Will I sell? Hmmm, I think I possibly will.

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EPIC BLND BLND BLND
       
Date (1) 22/05/2007 16/08/2007 18/08/2009
Portfolio Value now 13,997 13,683 8,178
Portfolio Value year ago 11,678 12,185 12,288
Net rental income 561 566 552
Average net rental yield (2) 4.4% 4.4% 5.4%
Net debt 6,671 6,274 4,775
Net Interest Paid (3) 313 314 168
Effective interest rate 4.7% 5.0% 3.5%
Equity %