Good news for reits after UK property’s worst month ever | Daily News Byte

The last couple of months have been difficult for UK real estate investment trusts (REITs). The dramatic slowdown that many analysts had predicted would be caused by the combination of the rising cost of debt and uncertain demand has resulted in dramatic devaluations.

According to Chronicle of Investors Analyzing, the 14 FTSE 350 Reits and five non-FTSE 350 Reits that posted updates in November reported a combined £1.5bn loss in the value of their assets, resulting in an average quarterly decline in European Public Real Estate Association (EPRA) net. Net assets (NTA) per share 4.4 percent.

The situation is more than just bad. October was the worst month on record for UK real estate, according to analysts at MSCI. The average return of -6.5 percent was worse than the -4.75 percent return during the height of the 2008 financial crisis, as well as the -2 percent return immediately after the Brexit referendum result and during the darkest months of Covid.

So, is there any good news for UK reits? Yes, some – but looking for them is like looking for hay in a haystack.

First, it’s worth noting that the £1.5bn valuation drop reported by Reits that posted updates this month was not spread evenly – and not every Reit posted a drop. The biggest losers were landlords with the highest exposure to warehouse assets. London Metric (LMP), Warehouse Receipt (WHR), UK Commercial Property Rights (UKCM) And Custodian Writ (CREI) EPRA posted the four largest declines in NTA per share values; All have portfolios that include at least 70 percent warehouse assets, with a warehouse REIT’s portfolio made up entirely of warehouses.

The severity of that valuation downturn comes after years of excitement about the warehouse market. We warned in April that investor excitement around the importance of warehouses in the shift to ecommerce could create a speculative bubble in warehouse values. After some time, Amazon (US:AMZN) Admitted that it had over-expanded its warehouse footprint, and share prices in large warehouse properties subsequently fell. The rise in bond yields during September further affected the value of warehouse assets. Property agency in October alone CBRE (US:CBRE) UK warehouse values ​​fell by 10.6 per cent – more than double the declines of 4.8 per cent and 5.1 per cent for retail and offices respectively.

Perhaps the biggest loss of all is not the warehouse writs, but British Land (BLND). It announced in late May this year that it was continuing to increase its interest in warehouses, and since then those assets have become the worst-performing part of its portfolio – down 6 percent in value. It’s one thing for Warehouse Reit and its ilk to lose money on a sector they’ve long supported after years of gains; It’s quite another for British Land to run into the cycle at the end only to burn out.

However, British land and warehouse writs have yet to have the last laugh. Despite the decline in valuations, leasing activity is progressing well. According to information from Savills (SVS), another agency, leased more warehouse space in the first half of this year than in any comparable period on record, while leasing activity for the third quarter of this year also looks strong given the growing pressure on businesses. One explanation for this is that, while the buying and selling of warehouses is part of a cyclical process, the leasing market is still gaining strength from the fundamental shift towards online shopping and, by extension, the increased need for warehouse storage space.

As a result, CBRE reported a 0.4 percent increase in rental income for warehouses in October, compared to just a 0.2 percent increase for offices and a 0.1 percent decline for retail. It also explains why the agency puts the national vacancy rate for warehouses at just 1.3 per cent – compared with 10.2 per cent for London retail and 8.3 per cent for London offices. No wonder then that even as a warehouse writ, Urban Logistics (SHED) And LondonMetric all recorded valuation drops, all of which also recorded increases in net rental income.

But falling property values ​​is not a bad thing for reits either. Last month, we noted that current losses in the market would attract countercyclical buyers. At the time, Reits seemed unlikely bidders for this cut-price asset. Care home developer Target Healthcare Reit (THRL) He summed things up on the investment front when he said “now is not the time to do much”. Since then, however, some Reites have felt more confident. AEW UK Reit (AEWU) LondonMetric chief executive Andrew Jones said this month that the sale of assets from open-ended funds was a “significant area of ​​opportunity”. Chronicle of Investors Following its results last week, it expects there will be “opportunities to buy quality buildings at distressed prices” in the coming months.

And not all Reits suffer from valuation falls. In fact, a select few have managed to register a rise in valuation. There were only two FTSE 350 Reits to do so Serious Real Estate (SRE) And Workspace (WKP), although the latter’s gains were only offset by valuation prices on a six-month basis – workspace actually fell by 1.4 percent on a three-month EPRA NTA basis. However, as modest as the benefits were, there is a rationale for them: both companies own mid-sized workspace assets that are offered on short and flexible leases.

The increase in valuation makes sense when you consider how attractive those buildings may be to many employers unsure of how much office space they need in a post-Covid world. Rather than committing to a plush office in central London for 15-years, businesses can choose from flexible, temporary premises from Shoreditch to Sunderland from flexible landlords such as Sirius and Workspace. There’s a catch, though, in that this same flexibility could hurt two REITs going forward as small businesses rein in spending during the next recession.

This pair can be contrasted with good news valuation-wise landsac (land). The worst performing assets in the latter’s portfolio were its city offices. These are usually leased to larger companies for longer periods and saw a 9.7 percent drop in valuations. However, the company understands the way the winds are blowing and is planning accordingly. At an industry event this month, the Reit reiterated its commitment to convert a “significant percentage” of its office portfolio into flexible workspace.

Rest of justice

Assessing the performance of retail in the ret space is difficult. Shaftesbury (SHB), Capital and Counties (CAPC) And New River (NRR) Posted valuations fell 3.6 percent, 2 percent and 1.5 percent, respectively. While this below-average drop in the context of the broader recession could be taken as evidence of bottoming retail asset values, that potential good news was not accompanied by a significant increase in rental income. An economic downturn is unlikely to make things better for the retail sector and its ability to pay rent.

Another area that is difficult to measure is long-term property investment. LXi Reit (LXI) And Asura (AGR) EPRA NTA recorded a below average decline of 2 percent and 0.8 percent respectively. LXi also reported a three-fold increase in net rental income thanks to the completion of its merger with Secure Income as Assura reported a still respectable 15 percent increase in net rental income.

On balance, it’s a good performance. What both Reits offer investors is long-term income from long-term leases to tenants with strong balance sheets. However, as encouraging as it sounds, no lease can guarantee stability—even if it’s signed for decades rather than years. In 2020, as the pandemic took hold, LXi struggled to collect rent from some of its tenants. The company has said all of those arrears have been paid, but the saga is a reminder of how tough economic times, as one economist predicts over the next two years, could also do to commercial tenants’ ability to pay rent. On a long lease.

Finally, there is self-storage. However, that fact makes it difficult to draw conclusions about the field as a whole Big Yellow (BYG) With results posted this month, it’s worth considering a fellow self-storage writ Safestore (Safe) His next results will tell a similar story. Big Yellow reported a below-average 1.7 percent drop in EPRA NTA, resulting in a pre-tax loss, but a 16 percent increase in net rental income. Demand for self-storage is seen by many as ‘recession-proof’ because of the way demand overcomes disruption – something that tends to increase rather than decrease during a recession. Investors will know whether that’s strictly true as the next recession takes hold, but Big Yellow’s performance so far has been acceptable on balance.

However, perhaps the best news for Reits is that recent price movements may not be indicative of their fate. REITs routinely praise valuations as a solid measure of portfolio performance in good times and curse them in bad, but on this occasion their skepticism about valuations is worth considering. LondonMetric, for example, could see a big loss in a three-month valuation change but if you compare 30 September 2022 with the same period last year, its EPRA NTA has actually increased by 7.5 per cent.

The date of all these assessments – 30 September – is also worth keeping in mind. At the time, Liz Truce was still Prime Minister, and her “mini”-budget triggered a sell-off in gilts that led the Bank of England to join an unprecedented intervention. It’s easy to imagine precious people struggling to see much beyond the chaos of that particular moment.

Since then, new Prime Minister Rishi Sunak and his plans for austerity 2.0 have stabilized the market somewhat, and 10-year gilt yields have now fallen to near where they were in early September at the time of writing. The outlook for demand is unlikely to improve in the near term, but this shift in yields – and the growing belief that the base rate will be lower than previously feared at its peak this fall – will prove helpful. If this continues, it will make December 30 property valuations look more favorable.