A New Year and just maybe a brighter dawn for the quoted REITs? As I type we’re about to finish the results season for the December year end companies. Results have varied between slightly worse than expected to reasonably satisfactory which against a backdrop of a calamitous Q4 22 “data set” from the direct market means it’s generally been better than anticipated by some.
So, the MSCI/IPD direct market performance measure which has been around for 35 years now, recorded the worst quarterly performance on record, with capital values collapsing by over 15%, a pace of decline that even exceeds that during 2008. Add some gearing to that, no matter how modest, and REIT NAVs have dropped sharply not that equity markets were expecting anything else. In fact so chilled was the equity market that as companies announced their figures the immediate share price reaction to everyone was that prices went up and in many cases have stayed there. Admittedly the equity market has been on a bit of a tear reaching all-time highs, but even against that backdrop the REIT sector has bounced about 30% from the depths of the last mini-budget, and is marginally outperforming the equity market so far this year. The temptation to say “it’s all in the price” is almost, but not quite, overwhelming!
Well it just might be! There are monthly measures of capital value movements reported by various agents. The CBRE Monthly Capital Value Index for the first month of 2023 measured a capital decline of, wait for it, just 0.4%! With rental values apparently rising by 0.3%, total returns were zero. So, from a Q4 annualised rate of capital values declines of over 60% it’s now potentially down to under 5%! Ludicrous, but in some ways understandable, because since financial markets have settled to a reasonable degree there is evidence of some confidence returning to the direct investment market. A couple of London office sales to overseas buyers on yields below 5% and indeed 4%, and nearly £1bn of sales in total so far is an encouraging enough start. Segro, arguably at the forefront of capital value declines given logistics values have been so hard hit, delivered an H2 portfolio decline of 17%, some 4% greater than the H1 uplift, but 7% rental growth and nearly 10m sqft under development of which 75% is pre-let. Impressive as always, but as importantly, “a degree of confidence is returning to the investment market.”
There’s going to be bumps, possibly big ones, in the road ahead but we’re confident that there remains global capital interested in UK and indeed European real estate. Markets are pricing in an end to rate rises and possibly a rapid reversal in inflation by the end of the year. We think the “trough” in capital values will now come by the end of June at the latest and we expect modest rental growth in most commercial property sectors. With 25% discounts to net worth commonplace to our trough forecasts and 5+% dividend yields to boot, the sector doesn’t look expensive, given we think much of the bad news is now priced in.
