REITs are split ever more markedly into the strong and the weak, with offices set to join retail on the wrong side of that divide – meanwhile, at last I’m getting a lie-in.
Testing times indeed. I’ve written here before about the bifurcation of performance within the quoted REIT sector into the haves and have-nots; or, as I described it, into the tortoises and the hares. Put simply, the former have premium ratings, access to equity, and are growing their businesses, which are characterised by exposure to the logistics market or long, well-covenanted RPI-linked leases or both, while the latter trade at big discounts to NAV, have rising LTVs, have failed to reduce gross assets through disposals and are characterised by an exposure to retail property. The pandemic has accelerated the trend to new highs and new lows; and even more REITs may be in danger of losing touch with the field.
With fewer REITs outperforming the broader equity market (the FTSE All Share), the fact that the sector has on average outperformed the equity market by some 4% over the year to date gives an indication of the spread between winner and losers. We’re not talking basis points here; we’re talking huge gains and losses. In terms of relative performance against the All Share, down more than 30% are British Land, Landsec, Hammerson, CapReg, Shaftesbury and CapCo, while Intu was finally put out of its misery by collapsing into administration. Heading in the opposite direction and up by 25% relative to the All Share are Assura, LondonMetric, Primary Health Properties, Safestore, Segro, Target Healthcare, Supermarket Income, Triple Point and Tritax.
I’ve been bearish in the extreme on retail property, especially so-called prime retail, since I forecast a 50% collapse in capital values five years ago. That now looks conservative, with a non-existent clearing level for even semi-forced asset sales of supposedly prime centres against a backdrop of almost every retailer demanding (and often getting) huge rent cuts, not all of which is pandemic driven.
Intu is bust and Hammerson has launched a deeply discounted £500m-plus equity raise, which may be enough to tide it over – but may not. It has also launched a new leasing model, with flexible leases, rebased rents at affordable levels, indexation instead of rent reviews, and an omni-channel top-up element for non-store-related sales. Good luck. The valuers are apparently happy that these changes will not severely impact values, and judging by the valuation of many European shopping centres they may be right… or maybe those centres are just overvalued? The fat lady hasn’t even started clearing her throat yet.
For those REITs on the right side of the increasingly great divide, then it’s logistics, already going strong but with a fresh impetus from the pandemic, or else the security of long-dated income, often with inflation-linked rental uplifts – albeit that isn’t much at present, but collared at 1% is probably more relevant than capped at 4%. The majority have IPO-ed or dramatically changed their business model since the global financial crisis; they have in-built and often compounding reversion. They are all paying dividends – and growing them, to boot. In fact, most have pretty decent yields compared with other standard forms of savings or investment, which seems to guarantee their continued upward path.
The one segment of asset specialisation missing from both lists is London offices. The two large specialists, Great Portland and Derwent London, have both been underperformers but not embarrassingly so. In other words, the jury (or rather the market) is still out on what the future direction is likely to be. I’m not. I confess to a full 180º rotation on my thoughts from April to May. In April, it was: this won’t last; we’re social creatures, we like to be in the office with colleagues working hard in between chats about sport, and we might occasionally have a glass together after a long day and tell each other how well we’re doing.
The biggest complaint was the commute: in our business that meant the six o’clock alarm, and home by seven at night if you’re lucky
By May I’d realised that we can for the most part work effectively from home, if less pleasurably in some cases – but, more importantly, employers have embraced and encouraged the trend. No one, but no one, now expects a full five-day week in the office for all staff, and not just for the foreseeable future but possibly forever. For someone who’s done more than 40 years in the City, I find that sad, sobering and fully understandable in equal measure.
The biggest complaint was of course the commute: in our business that meant the six o’clock alarm, then a full day and home by seven at night if you’re lucky. It’s pretty absurd really, isn’t it, even if the money’s good and the job’s great fun? The money is now less and the fun’s gone!
If staff are to be in the office less frequently as we remain socially distanced, with a recession looming and with excess space already hitting the market, I’m unconvinced that the future for London offices is anything other than really rather difficult. Luckily speculative development has been controlled and is low by historic standards, but I’ve always argued that while you can measure supply, you can’t (despite agents’ efforts) measure demand. Sure, there will be lease events where tenants may seek to upgrade, but they won’t need as much space, and what they leave behind may not be a new potential redevelopment or refurbishment.
Q2 London office take-up was, unsurprisingly, very weak, but more worrying is the fact that the market wasn’t that far from negative net absorption – and when that happens, rents fall. Agent-speak currently is that prime rents are stable but rent-free periods are up by three months to 27 months on a ten-year deal, which to anyone who isn’t a London office agent means that a headline rent of £70 per sq. ft on 50,000 sq. ft for ten years should cost £35m but really costs £28m – and will now cost just over £27m. Hmm.
When arguably the very best in the business, Derwent London, says it expects occupation levels to reach just 65% by Q1 next year and rents to come under pressure as the vacancy rate rises, I can only hope the two-tier investment and occupier market that it and others are forecasting does emerge, with the strong investment currently circling the London office market maintaining investment yields where they are today… which is where they were in March. It might, but I’m very wary. My rule of thumb has always been that as the vacancy rate approaches 10% from either direction, rents either fall or rise accordingly – and it’s currently about 6.5%, up from 4.5%.
One final observation. In March 2009 Segro raised just over £500m in a 12-for-one rights issue at 10p against a closing share price of around 80p; look where it is now. Hammerson has just announced a 24-for-one rights issue to raise £550m, which after a share capital reorganisation will see shares issued at 15p against a closing price of 280p. Anyone out there envisage Hammerson replicating Segro’s recovery by 2030? Thought not.
