Shopping centres and offices are the surprise front-runners in the REIT scene.
In the spring edition of The Property Chronicle, I ventured to suggest that, while there is something for everyone in the REIT sector this year, retail property could complete the sector playing with a full deck of cards. To recount, attractive dividend yields and their surety of growth is available from a number of companies where you might not make much capital, but the income stream is long and strong. Logistics shows absolutely no sign of slowing down, with ultra-strong investment demand and ongoing rental growth. London offices are savaged by the bears citing a vacancy rate approaching 10%, but dig deeper and grade A vacancy is under 3.5% and the development pipeline muted ahead of a disproportionately high concentration of ‘lease events’ over the next three years. Throw in the ‘E’ in ESG as a growing and important requirement for occupiers, and I have little doubt that tenant demand will focus solely on only the best space available, of which there isn’t much. Rents will fall a bit this year, but could rebound strongly next and investment demand is well evidenced.
With so much, possibly too much, money floating around and seeking a home, offering income, we saw the start of investor interest in retail parks on high single-figure yields last year. This year that sub-sector has seen yet more capital from seasoned buyers, with pricing at worst stabilising. Then finally, a quoted company, no less than Landsec, announced with its recent final results that it was eyeing opportunities to acquire ‘destination’ shopping centres. It was music to my ears! While the travails of much retail property is well documented, we are seeing the best shopping centres now valued with 7-8% yields and, with rental values having tumbled, peak to trough declines in capital values will be 50% plus. We are yet to see the impact of the likely ending of the moratorium on tenant eviction for non-payment of rent and that could play out painfully. I still cling to the view that the vast bulk of the pain has been taken and rental values have fallen to such a level that retailers can now make money, with landlords desperate to avoid higher vacancy rates and likely to reach an accommodation with their tenants – or customers, as they’re now called.
“Successful retailers still regard the physical store as a critical component of their omni-channel offering”
Turnover rents for sure and a painful re-setting, but they’re commonplace elsewhere and valuation yields across much of Europe for shopping centres are still lower than in the UK. Retailing always reinvents itself in some form and while online sales penetration has rocketed in the pandemic, successful retailers still regard the physical store as a critical component of their omni-channel offering. More pain to come, but I was the first ultra-bear on the asset class over five years ago and I’m probably the only one on the sell side who will now countenance giving shopping centres a small tick in the box. Year to date, the pure retail plays are the best performing shares in the sector, admittedly from levels that were discounting Armageddon.
So, they won’t like the description, but the two ‘dinosaurs’ of the sector are Landsec and British Land. They both trade on hefty discounts to their NAVs, perhaps understandably so, given that REIT investors much prefer companies to invest in a single asset class. However, the bulk of both companies’ portfolios are comprised of London offices (tick), some retail warehousing (tick), shopping centres (tick?), potential big London office development programmes (big tick), and aggressive asset rotation, as in sales to fund CapEx (tick) and lowly geared balance sheets with relatively cheap debt.
All the doubts about the future of retail and the future demand for London offices are fully reflected in current share prices, with scant regard of the potential for future value creation. I think we’re at the nadir of retail valuations, certainly for the big shopping centres, and I expect London office rents to fall a bit, but asset pricing to be flat at worst over the coming six months.
“Very early indications point to tech, financial, legal and media tenants showing more than a passing interest in some of the space being created”
We’ve just had final figures from Great Portland, a company with an outstanding track record of value creation and asset rotation based on a near-perfect reading of the London office market over the past decade. The figures released were largely irrelevant when compared to what I can only describe as the most positive commentary espoused by the company in many years. This was full on positivity from a management team who tell it as they see it and make no apologies for so doing. ‘Talk’s cheap, money buys whisky’ is a longstanding phrase I love and GPOR is committing to a very significant development programme over the next few years. Very early indications point to tech, financial, legal and media tenants showing more than a passing interest in some of the space being created. Landlords, developers and occupiers are all responding to the ‘E’ in ESG, the green agenda, with the vast majority of existing London office space not fit for purpose given current EPC legislation and aspirations.
Just to add a bit more fuel to a potential REIT blaze, the oodles of private equity money looking for a home in real estate has just seen Blackstone confirm a formal all-cash offer to St Modwen at well over a 20% premium to St Mods last NAV and a slightly bigger premium to where its shares traded pre the announcement. The board is recommending the bid. The shares were one of my three nap stocks for the year, he says modestly, based simply on the fact that the group’s house building business is doing very well and is probably saleable, and the rest of its assets, the bulk, are logistics assets. As such, why was it trading at a big discount to NAV when other logistics owners were trading at a premium? The share price just wasn’t reflective of the company’s net worth or its potential. Clearly I wasn’t alone in spotting that.
It’s not often I adopt a really upbeat stance on the sector and it’s oft been said that I’m a better bear than I am a bull: not at the moment. All to play for!
