We read REITs’ reports and accounts from back to front for those interesting notes tucked away. This year, both Landsec’s and British Land’s reports include new data on portfolio energy performance.
We think the market is underpricing REIT climate risk compliance ahead of the government’s energy white paper ‘Powering our net zero future’. This proposes that rented non-domestic buildings meet minimum energy standards by 2030, otherwise maximum lease terms fall short of the minimum 10 years overseas buyers accept.
The new negative is that 70% of Landsec’s and British Land’s portfolios measured by area (although sector, ERV and values are more relevant) fall short of the minimum A and B Energy Performance Certificate ratings.
We expect fuller disclosure with interim reports in November, but our analysis of the ‘known unknowns’ concludes that Landsec’s and British Land’s decarbonising costs and dependency on shop rents will squeeze their earnings.
We estimate Landsec and British Land face ’greening bills’ of around £250m
Discriminatory pricing of London offices is already here, with green premiums and brown discounts. The new ‘Tesla class’ of ‘clean and green’ buildings rated A and B are in short supply and comprise less than 10% of London office stock and just one percentage point of the current 7% vacant stock.
While C-grade buildings can be cheaply ‘upcycled’ to B-grade, these costs increase down the alphabet to the smoky ‘Trabant grade’ F- and G-rated buildings, which could face large retrofitting costs. We estimate Landsec and British Land face ‘greening bills’ of around £250m, or 4% of their NAVs.
Over half of Landsec’s and British Land’s income is dependent on shop rents (including leisure) and while retail parks are rebounding, much of the retail market hasn’t fully reset rents and downsized.
REIT malls are valued at around 7% yields, but the Lendlease retail fund sold Touchwood, Solihull, at a 9% yield and Bluewater may prove unsaleable.
Unlike US REITs – which generate higher levels of retained cash after all costs including dividends – the traditional UK REITs have low-income returns. They are dependent on external capital, but their shares trade at 30% discounts to book value, with investors resistant to gearing much above a 30% loan-to-value ratio, so they must generate more cash internally.
We conclude that Landsec’s and British Land’s earnings will contract and, after a year and a half of buying their shares, have downgraded our 2022 dividend forecasts by 19%, which winds the dividend clock back more than a decade.
Landsec’s and British Land’s shares have been weak on rising inflation, with June CPI at 2.5% stoking fears about interest rate rises, and both are in danger of dropping out of the premier league FTSE-100 index.
Administration costs are also coming under greater scrutiny. Landsec’s were £80m and British Land’s £74m in 2021 for managing portfolios of £10.8bn and £9.1bn respectively. The £3.2bn, multi-sector L&G Managed Property Fund has fewer than 10 asset managers.
We still prefer our moniker ‘beds, meds n’ sheds’, which might sound kitsch, but has now passed into everyday property speak. It is shorthand for REITs with higher cashflow from simpler buildings and thus portfolios that earn their keep.
When UK REITs were introduced in 2007, Landsec and British Land ranked sixth and seventh in the global REIT league table. Following the global financial crisis and REITs calling for £7bn of rescue rights issue money, they have slid down to 81st and 82nd. That can’t be blamed on Brexit, Covid or the British weather.
Mike Prew is managing director at Jefferies