The UK’s listed real estate sector was hard hit by the taper tantrums of 2015. It tried to recover but any hope of a return to the bull market conditions which prevailed from the lows of 2009 were snuffed out by Brexit. The sector hasn’t been the same since.
Certainly, that is what you would think if you looked at the Landsec share price. Five years ago it was 971p; today it is 980p, having celebrated the 2015 results along the way with a peak of no less than 1,453p. And Landsec is not alone. The British Land chart looks pretty similar albeit that the share price is 10% higher than it was five years ago.
Look at Landsec’s financial results and the picture is rather different: Net assets grew from £7.1bn in 2013 to £10.3bn which was rightly celebrated in 2015. Since then the number has drifted sideways – up slightly in 2016, down slightly in 2017 and, if forecasts are to be believed, up again to around £10.8bn in 2018. A billion pounds of debt has been repaid, the LTV has come down from just over 35% to almost 20% and the quality of the portfolio has been improved markedly with the sale of swathes of mid-tier retail and the redevelopment of much of the office portfolio, yet the shares trade at a 33% discount to the likely 2018 NAV.
Maybe this is because the shape of the portfolio remains broadly unchanged with 47% in London offices, 43% in retail (roughly a third of which is in London) and 10% in hotels and leisure.
Sentiment towards the London office sector was particularly hard hit in the wake of the Referendum. You only have to look at the Derwent London share price to see that: it fell 42% from the 2105 peak to the post Brexit low while LandSec was down a mere 31%. What is interesting is that the London companies, Derwent London, Great Portland, Workspace and Helical Bar never lost their nerve. They are not heavily exposed to the City and its presumed Brexit woes, they trusted in the tech sector, which remains vibrant and apparently immune to Brexit and kept on building and letting space. They have been rewarded with firm rents and their valuations have been supported by a continuing flow of international capital which seems to be able to look through any short term dislocation to the long term advantages of the UK in general, with its stable economy and robust legal system and London in particular with its unchallenged role as a World city. It has taken a while, but a steady flow of supportive letting and investment evidence and a more relaxed attitude to the risks inherent in Brexit is now bleeding into share prices. Derwent London, for instance, is up 36% from its Brexit low, having paid two special dividends along the way, and Workspace which is most exposed to the new economy is making post crisis highs, having comfortably broken clear of its 2015 levels. Given its 47% London office weighting some of this should be rubbing off on Landsec (and British Land).
While sentiment towards London offices is recovering, the same cannot be said for retail. Here attitudes are being set by investor perception of the retail sector where internet penetration is on a constantly rising trend and a steady stream of retailers which have failed to adapt are reaching a tipping point beyond which they are no longer viable, with House of Fraser the latest to contemplate a CVA. It is salutary to note that the stock market now believes that ASOS (market capitalisation £5bn) which according to Bloomberg is likely to make net profit of £78m in the coming year is more valuable than Marks & Spencer (£4.7bn) which makes five times as much money. Indeed on this measure it is rapidly catching up with Next (£7.3bn) which is forecast to make £576m and which derives half of its sales from the internet. Against this background it is hardly surprising that the stock market can’t get enough of the distribution sector while physical shops are almost universally shunned. Relative winners, like Hammerson, are tolerated but any suggestion that they might exploit their relative strength by acquiring good assets from weak holders is met with a stony stare. This is understandable, but disappointing because the economies of scale – in terms of access to debt, cost savings and, most importantly, the ability to engage with successful retailers like Apple across a continent wide or even global portfolio – are compelling. Like Landsec, the Hammerson share price is back to where it was five years ago while Intu has lost a third of its stock market value since then. While Landsec did the right thing in selling its weaker retail, in share price terms it is being punished for reinvesting into Bluewater and Oxford and perhaps for being sub-scale in a globalising sector.
Portfolio mix is part of the explanation but by no means all of it. Along with British Land, Landsec is one of the few UK property companies to make it into the top tier globally. This matters because much of the capital invested in the sector is managed on a global basis and these stocks are consequently going to bear the brunt of any enthusiasm (or otherwise) for UK real estate. Post Brexit, there has not been a lot of love for the UK among this group of investors.
And then there is the emergence of a plethora of new companies which have grabbed the attention of investors. This happens in every bull market but historically the new companies have turned out to be shooting stars which challenged the leaders but which ultimately turned out to have been built on sand. Who now remembers Rosehaugh, Stanhope and Mountleigh? This time around it is different. The new companies are typically REITs with a focus on deriving income from rent with a view to passing on as much of it as possible to investors in the form of dividend. Typically, they have the same balance sheet discipline as the traditional investment companies and, typically, they have a specialisation in a sub-sector with better initial yield and growth prospects than London offices and top 40 shopping centres. Some of these companies are now very substantial, notably Tritax (£2.2bn market cap), Assura (£1.4bn) and LondonMetric (£1.3bn) and there is an increasingly long tail of new entrants particularly in the long dated income and social housing sectors coming to the market and doing follow on issues. I recently tried to list them all and lost count at £18bn. Dividend yields range from around 4% to as high as 9%, which Landsec on 4.1% can only challenge by trading on a 33% discount. These companies seem to operate almost as if they are in a parallel universe, providing private investors – either directly or via their wealth managers – with reliable income streams, while the rest of the sector continues to be owned by mainstream institutions, index ETFs and specialist funds. At some point these ‘new’ investors will start to focus on the dividend yields offered by Landsec, British Land (4.5%), Hammerson (5.0%) and Intu (7.2%). In the meanwhile, the best of the new companies will continue to get bigger to the point where they challenge the old order. Tritax is already nearly as big as Intu in market cap terms while my own tip for the top is PRS REIT which, while currently a mere £0.5bn, is building a portfolio of tenanted houses; £1bn buys you around 750, which is a flea bite in a country with 28m households.
Finally, there is a growing group of companies which trades at or above (in some cases substantially above) NAV because their particular specialisation is performing strongly. Workspace, Tritax, Assura and LondonMetric have already been mentioned but the list of stocks trading at post recovery (or indeed all time highs) includes Big Yellow and Safestore in self-storage, Unite in student accommodation and SEGRO which has emerged from the chrysalis that was Slough Estates in the form of a pan-European distribution specialist.
From which I conclude that the discount on which Landsec and, for that matter British Land, currently trades gives a misleading impression of the health not only of Landsec but also of the wider sector. For Landsec, the ‘problem’ is its non-London retail exposure, which amounts to around a third of the portfolio and which is obscuring the resilience of its London office, London retail and hotel and leisure assets. Clearly, there are very few investors who want to put more money into physical retail while the retail sector itself remains in a state of flux. But once you get away from that, the sector seems to be in remarkably good health, with a rapidly growing exposure to those bits of the UK economy which are either growing or which are capable of pumping out reliable income streams or, better still, both.
