Originally published July 2023.

Some listed Propcos are now a “buy” and here’s why…

It is ironic that the thing the listed property sector seems to need more than anything else right now is a jolly good recession, isn’t it?

There are several decent property companies out there. Why, then, are they trading at such big discounts to net asset value in the listed markets today?

Let’s stop for a second and think about what that means. £1 of property assets (net of liabilities!) can now be purchased for 65p, or less in some cases. That looks interesting right now if you pick the right company. And if you have the nerve and the patience to believe that the discount will narrow through share price appreciation, as opposed to valuations coming down!

Dividend yields on some of those shares are around 7% today, even for some of the better managed portfolios; a level at which the discounted cashflows would not be able to purchase the underlying assets. So, could these shares be a bit of a bargain today? The equity market doesn’t seem to think so.

My view, for what it is worth, is that 7% is quite an attractive dividend yield as we are likely past the peak of the inflation cycle and interest rates likely near their peak. (If you are looking for yield, some other types of financial services companies offer close on 10% per annum, but their assets go home each night which is quite a different proposition!).

At some point, recession, or a version of it will bite, and interest rates will come down again and there is more than one scenario in which this could happen quite sharply.

Let’s do a little maths…

Let’s say it takes two years until interest rates normalize to 3% again, (many economists are more aggressive than this, both in speed and quantum). Let’s say those discount rates correct to show a 15% discount to NAV (i.e., not all the way back to NAV, or, in another way of putting it, allowing valuations to fall a little further before they find their level).

If those (I think reasonable) assumptions came to pass, from these share price levels you could potentially pick up 20% capital gain and close on a 7% p.a. dividend yield whilst you wait. That’s a total return comfortably over 30% over the next two years. If it takes longer, say four years, your annual return falls, but to a still healthy 10/11% per annum compound total return over the period. If core inflation stays stubbornly high at say 5% per annum over the period, that is still a near 6% real return over four years. Higher than long term averages.

So, what’s not to like? Well, a few things actually. The reason you would not buy REITs today is that you think that their asset values are not believable and will fall further, that they will not be able to refinance their portfolios, that other shares are more attractive, and that you will be faster than the market to spot the nadir in the share price and get back in there before others do.

On the first argument, some management teams have ‘proven’ their underlying valuations are correct by selling one or two of their assets at those values recently. On the second, some LTVs are now below 20%; never say never, but these companies are not going bust. On the third, all shares benefit to some extent when interest rates are falling as the future value of their cash flows increases, but few if any others correct in quite the same way as a real asset backed property company, where the underlying book value of the assets increases too. And fourthly, if the share price of a better than average REIT can fall over 17% in a week, (as one recently did!) believe me it can correct that fast too. And that’s a year of your prospective gain from here. I am almost certain that you will miss it.

Markets today are emotional and fearful. Especially the REIT market. Follow the maths; be logical and greedy.