This article was originally published in December 2019.
Institutions are increasingly pushing underperforming listed property companies to take steps to create value, Guy Barnard of Janus Henderson and Alan Carter of Stifel tell the Property Chronicle.
Managers of UK-listed real estate companies have had a tough ride over the last few years, waiting for the uncertainties of Brexit to clear, but some should prepare for more testing times ahead, according to two established players in the sector.
Guy Barnard, co-head of global property equities at Janus Henderson Investors, and Alan Carter, salesperson at Stifel, say the stark division between favoured growth stocks, accorded a premium to their assets, and shunned value plays, trading at a discount, can only get more pronounced.
“I have been unswerving in my views over the last four years to buy the expensive stocks and sell the cheaper ones. You might say that turns everything on its head. But this is Darwinism at work in its most effective way,” says Carter.
“What’s doing well will continue to do well and what’s doing badly will continue to do badly. Those with premium-rated paper are largely in control of their destiny but weaker ones, with no currency, will be blown around with what occurs, largely outside their control. I don’t see what changes that.”
Barnard says: “The market is prepared to pay a higher rating if it trusts the level of growth going forwards and is stand-offish where there is disruption or uncertainty for earnings. Until there is light at the end of the tunnel catching a falling knife becomes a dangerous game for investors.”
The acquisition in October of US trust Liberty by fellow logistics asset owner Prologis exemplifies this trend. Prologis, Barnard’s biggest holding, made an all-share offer valuing Liberty at US$12.6bn, a 20% premium to its net assets. That was in line with recent deals from the likes of Blackstone.
This made sense given Prologis’ own low cost of capital – its own shares have been trading at a 35% premium to net assets – and the benefits of scale in the sector.
Such companies benefit from being able to use their equity as currency to make acquisitions. “They get the double whammy of being able to grow externally which is very accretive to earnings and dividends,” says Barnard.
“They don’t need another chief executive to manage additional assets. The good getting bigger and becoming more efficient is something we support.”
For the unloved companies in the sector, the situation is grim indeed, however. Managements of such entities are vulnerable to being taken over by the better ones seeking to expand.
Carter is blunt about this. “There is little doubt that in certain instances the remuneration of chief executives and finance directors significantly overstates their contributions to what value they have achieved for their companies.”
Barnard is also casting a critical eye over management. “We and other institutional investors are examining management remuneration proposals with a far higher degree of scrutiny today than was the case several years ago,” he says.
“We are trying to find out whether they are aligned with shareholders’ long-term returns. We are voting more actively and expressing our dissatisfaction where we don’t think things are as they should be. I think that pressure will only continue.”
Up until the end of 2015, property companies had an easier ride, contends Carter. Quantitative easing effectively meant all assets increased in value willy-nilly. At the same time rents were still rising and tenant demand held up better than expected.
“It’s only over the last four years you’ve started to see this disaggregation between winners and losers, when cap rates have stopped falling in most sectors and as rents have started to stabilise or fall back in London offices,” he says.
“The losers have continued to be extremely well remunerated while giving pretty tardy returns for their investors. It’s most obvious in the retail sector. Retail companies were so late to accept what the vast majority of people had worked out: that retail was going through a very difficult period.”
Institutions’ gaze will most firmly be fixed on companies which have been trading at a discount to their net assets for some time, says Barnard.
“OK, there is a cyclical element and Brexit uncertainty does not help, but when you see discounts sustained for a long period then I think if you believe your NAV then you should be selling assets to close the discount or buy back stock. Or, more extreme, do what Green REIT has now done.”
That Dublin property company’s management recently said it would tender for shares at its NAV of €1.3bn and go private after a sustained period of seeing its stock trade at a 30% discount to its book value.
“That should be applauded,” says Barnard. “If you are trading at a materially lower rating and not delivering returns greater than your peers, there will be pressure to explore strategic alternatives.” Many of the companies trading at a discount are those which have a mix of assets in their portfolios.
“There will be more specialisation over the medium term. Those diversified business models maybe made sense a decade ago but having missed some of the big sector calls, why is 50% office and 50% retail the right structure today?”
Managers of companies such as British Land and Landsec, which maintained such diversified models, should have woken up sooner to these risks. “The demise of retail should have been evident to landlords,” says Carter. “They should have been looking at alternatives then but they failed to do so.”
He thinks it is “not inconceivable” that such companies could be bought out by private equity and split up in the future. “The management teams need to answer to shareholders.”
Carter remains bullish overall with interest rates so low. “The asset class remains under-owned globally by institutions and there remains a requirement for dividend yield or some form of income. It’s relatively low risk and relatively low return. It ticks many boxes in the current environment.”
Barnard says the defensive qualities should be quite attractive in the current environment. “REITs globally are doing their job as a relatively defensive part of the equity market. People are less worried about missing out on all of the upside, if markets go up 20% from here, but are looking to protect themselves in case we see a 20% correction.”
He believes if Brexit completes, the UK market could take off quite rapidly too. “There is a lot of money to be deployed in the UK market waiting on the side lines. There are yields in London that are hard to find elsewhere in European cities.”
That said, Barnard sees the best opportunities in niches outside Europe at the moment. He likes Sun Communities and other providers of retired housing in the US for example as well as gaming REITs, which have properties let out to casinos on very attractive terms.
“You can buy some gaming REITs at 9% cap rates with guaranteed cashflows for 20 years that escalate by 2% annually.”
Carter continues to stick in the main with those companies that have floated, post the REIT regime’s introduction, that offer guaranteed uplifts through long-dated often RPI-linked income, lowly geared balance sheets and no development exposure. REITs that “do exactly as they say on the tin.”
He says: “What is clearly of vital importance is long leases let to good companies with fixed uplifts that are RPI-linked.”
Management is also of importance and Carter tips Intu’s new boss Matthew Roberts as one to watch as well as former Unite chief executive Mark Allan, who is now running St Modwen Properties.
