The shrinking universe of London-listed real estate investment trusts (REITs) is expected to decline further in 2024, as the sector struggles under the weight of low assets, weak share prices and high discounts.
Warehouse investor Tritax Big Box on Monday revealed a £924 million deal to buy rival UK commercial property REITs, lining up the creation of a nearly £4 billion property giant that some experts say has the potential for a future membership in the FTSE 100.
UK commercial property acquisition continues LondonMetricThe £1.9bn total share acquisition of LXiand the announced merger of Abrdn Property Income with Custodian Property Income REIT in January.
M&A activity among UK REITs has accelerated since 2019 and is expected to continue, but some analysts say the consolidation bodes well for the future fortunes of the ailing sector.
The real estate sector is generally negatively affected by rising interest rates
An analysis by Bryan Cave lawyers Leighton Paisner in May 2023 found that the number of REITs listed in London had fallen 20 percent, from 83 at the beginning of 2019.
That number now stands at 48 REITs, according to the London Stock Exchange Group website.
Data from the Association of Investment Companies shows that only seven UK-listed property trusts are currently showing positive one-year share price performance, while 17 funds have recorded double-digit declines.
Hefty double-digit discounts to NAV are also common, with trusts in the UK residential, commercial and logistics sub-sectors currently averaging a discount of 42.6, 21.3 and 19.4 per cent respectively.
The two existing healthcare REITs are discounted by about 29 percent each.
Stephen Inglis, chief executive of London and Scottish Property Investment Management, recently described 2023 as “one of the most challenging years for REITs in recent times.”
Inglis’ company manages the regional REIT, which is currently enjoying a dramatic discount of more than 70 percent and “is not immune to the macroeconomic headwinds facing the sector,” he added.
BCLP said: “As long as stock prices remain depressed, raising equity capital remains a challenge and credit markets are tight, we anticipate acquisition activity in this market will continue as more companies seek to scale through transactions. merger or are the target of cash transactions. wealthy investors, including private equity firms.
London is not alone: REITs in the US also look cheap compared to stock market valuations
REITs hit by rate hikes
While the problem is particularly acute in the UK, London-listed REITs are not alone among their global peers facing a difficult trading environment.
REIT share prices have struggled globally for two years amid rising interest rates, which generally weigh on the attractiveness of real estate assets.
Analysts at Principal Asset Management said: “REITs are trading at historically significant discounts relative to the broader equity markets, thanks primarily to the interest rate sensitivity of the REIT market.”
They added that the weak share price performance also reflects “investor concerns about the real estate sector’s challenges: rising financing costs, lower availability of capital, outsize debt maturities and struggles in the office market.”
Principal AM said: “However, these concerns are largely misplaced as balance sheet leverage is, on average, less than 30 percent, REIT debt maturities are quite manageable, multiple sources of capital such as equity or unsecured debt, are open and exposure to The traditional American office is below 4 percent.
And as interest rates peak and central banks are set to begin easing monetary policy amid falling inflation, 2024 could mark a “recovery year for REITs,” he added.
Bigger is better
While REITs have suffered from a sharp rise in interest rates globally, UK companies have struggled relative to their US peers largely as a result of their stark difference in size.
Most London-listed property companies have less than £1bn in total assets, according to AIC data, and the sector dwarfs that of its US peers.
John Moore, senior investment manager at RBC Brewin Dolphin, said: ‘At their current scale, UK REITs are limited by their size.
‘This has an effect on the capital they can attract, the terms on which they can borrow and, ultimately, the deals they can close.
‘Combine them all and you get just one of North America’s leading real estate asset managers – they simply can’t compete on a global scale.
“Some REITs are having to raise substantial sums privately, which restricts them and means they can only invest £1 billion when, in reality, they should be talking about multiples of that figure.”
Therefore, consolidation in the UK REIT sector has the potential to improve performance and shareholder returns in the future, according to BCLP.
It said: “While it is disappointing to see the UK listed property sector contracting, there are many sub-scale companies and there is no doubt that investors would be better served by larger companies with greater share liquidity, lower cost ratios ( as a result of economies of scale) and greater access to debt capital markets.’
London-listed property trusts suffer deep discounts, weak share prices and low assets
The link between Tritax Large Box and UK Commercial Property REIT fits this logic, as the combined property company is “potentially the fourth largest in the UK and a candidate for future inclusion in the FTSE100”, according to Oli Creasey, property research analyst at Quilter Cheviot.
Tritax Big Box is the fifth largest in the real estate sector and had recorded a one-year share price return of almost 10 percent, but continues to trade at a 17.2 percent discount to the net asset value of around of £11 million.
UK Commercial Property is also among the largest and best performing trusts, with a one-year yield of 23.5 per cent, but is at a 20.7 per cent discount to the net asset value of £81m.
Creasey added: ‘It would make sense if (UKCM’s) manager Abrdn was now looking for a… deal to help the trust grow scale, presumably with input from the largest shareholder.
“This follows a recent trend of consolidation in the property industry, with the other notable transaction currently underway between LondonMetric and LXi being another example of two companies looking to build scale.”
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