We’ve seen more evidence that US exceptionalism will continue unabated under president-elect Donald Trump and a sense of inevitable doom hanging over the UK recently. Yet, it’s worth noting that, from an investment perspective, there are pockets of good news emerging on this side of the pond.
One area of interest is property, where capital values are starting to stabilise, suggesting we’ve seen the bottom of the cycle and buoying real estate investment trusts (REITs).
Picton Property Income returned to profit in its half-year to 30 September, with a modest but still significant like-for-like portfolio valuation increase of 0.8%. Larger REITs such as Land Securities and GPE reported a similar experience, with values for prime London assets showing an increase in value.
TR Property, an investment trust that specialises in investing in REITs, more recently registered a 7.7% gain in net asset value per share in its half-year result to September.
Corporate activity in the sector is coming thick and fast too, leading many to become more bullish on the outlook. TR Property’s manager Marcus Phayre-Mudge noted “a positive shift in sentiment, marked by a renewed wave of offensive capital raising alongside continued merger and acquisition activity”. Indeed, Phayre-Mudge told us recently that, at 15%, the trust’s gearing was as high as it generally gets.
However, Phayre-Mudge acknowledged that, while encouraging, the recovery in listed real estate has been bumpy and this is likely to continue. The all-important 10-year gilt yield has, for instance, risen once more to just over 4.5%, following a similar path to US Treasuries.
Not all property is prime London, either, so it’s unlikely that the message across the whole REIT market will be quite so clear cut.
Still, there are positives to take forward as we gaze into the new year. One of those is that, despite a tough backdrop for property valuations and volatile macro conditions, REIT managers haven’t stood still – far from it.
In the case of Picton Property Income, it has been proactively reducing its exposure to the troubled office sector by repurposing buildings for alternative use. The most recent success story was the December sale of Charlotte Terrace in Kensington, West London.
It had already secured planning permission to convert the void office spaces at Charlotte Terrace into six residential units to take advantage of close-by Olympia’s £1bn redevelopment. The sale of Charlotte Terrace is expected to complete in January, with a price of £13.1m, a 5% premium to September’s external valuation.
Taking a slightly different, although equally valid, tack is Schroder Real Estate, which changed its investment strategy to capture and harness the green premium, the idea that environmentally efficient buildings can command both higher capital values and better rental yields than similar properties with a larger carbon footprint.
The green premium for London offices is about 20%, for regional offices 8% and for multi-let industrials between 5% and 10%.
The Stanley Green industrial asset in Cheadle, Greater Manchester, is a key example of Schroder Real Estate’s brown-to-green strategy in action. Among other things, the trust used highly thermally efficient partly recycled cladding in building new units and built air source heat pumps and rooftop solar panels into each unit.
Stanley Green was bought for £17.3m in late 2020 with an extra £9m in capital expenditure and was last valued at £40m in March 2024.
Alongside this proactive management of REIT portfolios and growing confidence amid rising property valuations, a further leg for a rebound in the UK commercial property sector is the fierce pace of corporate activity.
We’ve seen a mixture of mergers with other REITs and sales of whole portfolios to private equity buyers, showing that there are buyers out there seeing value in the current discounts to net asset value (NAV).
The sales of Balanced Commercial Property and abrdn Property Income’s portfolios were agreed at discounts of 8.7% and 12.7% respectively to their most recent NAVs. On the face of it, one might see this as disappointing, but Balanced Commercial Property’s transaction was at a 22% premium to the ‘undisturbed’ share price, with abrdn’s at 20%.
Looking back into the rear-view mirror, we believe that the stock market broadly got it right when prices of REITs fell rapidly in 2022 in response to rising interest rates. REIT valuations reached their low points long before the property market caught up.
Two years on and we’re in a different place. Property values have fallen by 20% or more, yet these transactions suggest the market today has overshot.
In addition, interest rates are on their way down (albeit slower than hoped), suggesting REITs look good value from an income perspective, with Schroder Real Estate offering a dividend yield of 7% with shares trading on a 17% discount, for instance.
Picton Property Income ’s 5.7% dividend yield, meanwhile, may be lower than some other comparable REITs, but it’s backed up by a reversionary yield of 6.9%, which could translate into further dividend growth. Picton’s 33% discount looks particularly attractive, too.
The pace of corporate activity is a timely reminder that even as the stock market is taking its time, professional property investors can see value in the market.
David Brenchley is an investment specialist at Kepler Partners. The views expressed above should not be taken as investment advice.