I turned bearish on the quoted real estate sector last September, since when it has fallen by 9% against an equity market that has barely moved. And the underperformance has continued over the results season.
This underperformance is of course notwithstanding companies reporting numbers either in line with or ahead of expectations. The big retail-owning companies offered a recovery, albeit modest, in rental values with ongoing yield compression. The London-centric businesses reported no abatement of tenant demand, with Derwent announcing a major prelet to Capita at a stonking rent with its final figures, while SEGRO re-affirmed the beneficial evolution in the logistics market with a strong set of numbers in its management statement.
Balance sheets remain lowly geared and falling, as are average debt costs. Development programmes are “tentative” by historic standards and the Land Securities mantra of funding capex from disposals is being embraced by most. Yet still the sector underperforms.
Brexit risk is the universally offered excuse and while hardly useful I believe it simply exacerbates what was already becoming evident, and the sector is reaping what was sowed.
Five years of quantitative easing may have prevented more than it has cured, but ultra-low interest rates and bond yields stimulated the search for income, property attracted global capital and an already underowned asset class had yields squeezed down, prices pushed up, and easy money made as cap rates tumbled.
Add in some economic growth with an absence of speculative development and rents started to recover and then grow. Turbocharged development returns helped by flat construction costs have been the order of the day. The quoted sector responded with near enough five years of uninterrupted outperformance.
While sovereign debt yields remain low, corporate debt now offers a yield greater than that offered by most REIT portfolios. This is something that REITs need to address in their results presentations, where most show how “cheap” property is against gilts – a commercial property is not a sovereign-backed source of income, as landlords to BHS and others are now discovering.
Sovereign wealth funds and overseas buyers have not deserted the investment market, but demand has diminished sharply while supply has not.
Development activity is far from reckless except in the London residential market where oversupply of the wrong type has hit a buyers’ strike, generating some horror stories as the pace of sales collapses and pricing has not moved to reflect this just yet. Capital growth, ex-development programmes, is ever more muted and to compete for equity investors’ capital there remains one, and only one, attraction: income or dividend yield.
The sector’s downward move is simply a transition from stalling capital growth prospects towards the more sustainable attractions of dividend yield, and not all prices tick that box yet.
My view was always that slowing economic growth would diminish tenant demand and bring an end to rental growth in many markets as the year passed. Throw in this Brexit “pause” and you have a situation in which all hopes now rest on a major rebound in confidence post the likely “remain” vote. Neither that rebound nor remaining in the EU are a given.
Meanwhile, the investment market in February posted activity that was a near five-year low. This slump was rather oddly described as being caused by a “temporary lack of liquidity rather than a seismic shift in sentiment”.
One month’s data is hardly empirically sound, but something has happened to turn a traditionally busy month into an appalling one and if that were to continue, and indeed why not, valuers will need their red pens at some stage this year to reflect what share prices have been saying for six months now. A stamp duty rise up to 5% hardly helps either.
It’s not tin hat time, but the summer boater can be packed away for a while yet.
Alan Carter is managing director, specialist sales, Stifel Nicolaus Europe
