Are REITs suffering from Stockholm syndrome, the unusual bond that sometimes develops between hostages and their captors? REIT chief executives seem to be mesmerised by property valuations that aren’t the same as prices. Consequently, they risk buying shares back at the wrong prices and not selling their businesses at the right prices.
Our shopping centre capital value forecasts have been downgraded to -45% from -30%, of which around -10% has been booked to date. Interim results from Hammerson (29 July) and intu (31 July) will be even more topical if Hammerson’s assets are revalued by Cushman & Wakefield for the 17th consecutive year. We think these specialist retail REITs need radical surgery with extensive disposals to de-gear into a market vacuum, but there is a buyers strike.
Intu’s sale of 50% of its Derby centre was a preference share trade that left intu with most of the risk and now all mall buyers are angling for similar structures. Shop tenants are no longer picking up all the operating costs of business rates, service charges etc, so REIT profits are being squeezed. The smoking gun is the consensual sale of The Fort, Birmingham, which could trade at 7% to 8% and should reset valuations.
London offices are also under pressure from April tax changes and Chinese capital has been frozen out. The Chinese spent $7.5bn (£6bn) on offshore real estate in 2018 but were net sellers in the second half of last year. This leaves pricing looking vulnerable to WeWork soaking up less space, office densification, Crossrail, technology and so on.
The RICS Red Book might have been appropriate for 18th-century agricultural surveying but isn’t suited to the 21st-century commercial market. REITs haven’t traded at their ‘rule of thumb’ NAVs for four years since we sold the sector and now trade at 45% discounts. Earnings might look stable and dividends high at 6% for the larger REITs, but some are looking unsustainable.
REITs are like Chelsea buns with the currants being picked out as they are forced to jettison the tastiest assets the market will buy. The ‘reverse QE trade’ for REITs is paying back free money as they de-gear and sell retail assets but are repaying bank debt at, say 1%. This results in self-inflicted earnings dilution and dividend cuts that we have forecast for Hammerson, British Land and intu, with more to come. REITs risk ending up with more stodge than fruit in their buns, meaning poorer-quality assets and earnings in future.
There are M&A warning signs. Helical was holding out for its 482p NAV from US buyers who don’t seem prepared to pony up, and Hammerson’s shareholders still find it hard to forgive the dismissal of Klépierre’s 635p approach, which is now worth around £6 against Hammerson’s shares at a low 270p.
Unibail’s Westfield buy
Australians say never bet against a Murdoch or a Lowy, but Unibail did the latter in buying Westfield expensively too late in the cycle. The €10.80 (£9.75) dividend may prove as ‘inviolate’ as the US REIT Equity Office Property $2 dividend was. EOP cut its dividend to $1.32 in 2006 and Blackstone then bought EOP for $23bn when chairman Sam Zell sold out ahead of the financial crisis.
We expect more REIT execs to bail out before the bail-outs. British Land lost its retail and offices head, intu’s CFO succeeded the CEO, after two years of pondering, Hammerson’s CFO resigned and Workspace’s CEO and Landsec’s heads of retail resigned. Changes in chairmen tend to precipitate senior management changes and the CEO’s role is to devise a strategy and put the right people in place to execute it. The retail blame doesn’t roll down the REIT organogram too far.
Retiring Landsec CEO Rob Noel’s career was in two halves. The first saw the masterful sale of £8bn of kit including grade-B malls in Dundee, Sunderland and Bristol. Reinvesting, however, included 30% of Bluewater at a nosebleed 4% net initial yield at the top of the market in 2014. That’s not just looking back with 20x20 hindsight. The REIT underbidders were left crying into their Hendricks and tonic that they had missed out.
We are sticking with our ‘beds, meds and sheds’ alternatives, which are going mainstream rapidly. These can access equity, expand, consolidate, reduce unit management costs, pass on savings and earn a consolidator premium, for example Unite Group (beds), PHP (meds) and LondonMetric (sheds).
The latter is reminiscent of Derwent buying LMS in 2007 to form Derwent London. Both are game changers with the willing seller getting a premium price and the willing buyer paying with highly rated paper, which shows management shareholders can’t get enough of a good thing. Counterintuitively, the premium stocks are probably still worth buying and the deeply discounted former majors look cheap but probably aren’t good value.
Mike Prew is managing director at Jefferies