Where to find value in the commercial property sector
Commercial property – notably shopping centres and offices – has struggled due to Covid-19. But there are several promising real estate investment trusts that look attractively priced, says Max King.
The share prices of commercial-property companies collapsed in March 2020 along with the broader market as investors pondered the impact of lockdown on rents and valuations. Soon, though, investors started to see winners – notably logistics warehouses, supermarkets and medical property – as well as losers, primarily shopping centres. In time, investors realised that some properties, such as student accommodation, were only temporarily affected; that gloom about other sites, such as retail parks, was misplaced; and that the setback to offices had been discounted in share prices to an excessive degree.
The overall return from commercial property in 2020, says the Investment Property Forum (IPF), was only negative by 1%, comprising a -5% capital return, but 4% of income. The capital value of shopping centres fell by 23%, but industrial properties appreciated by 4% and offices declined by just 2%, despite being largely empty for most of the year. The IPF consensus forecast expects a modest pick-up in 2021, with the industrial subsector continuing to do well, but retail poorly, before a broader pick-up in 2022. In that case, there is still plenty of good value in the sector.
Charlie Ellingworth, a partner at Property Vision, a property-investment adviser, says “this is no time to leave your capital on furlough. Though the dynamics of the sector are changing, commercial property remains an attractive asset class with yields averaging 5.2%, while interest rates are negligible”. Retail, he points out, still accounts for a third of the sector, but has been in decline for over a decade. As a result of overexpansion in the 1990s and 2000s, the sector is “over spaced by 40%”, according to Savills. Since the trend towards online shopping is not going to reverse, a lot of surplus space needs to be “repurposed”.
Remodelling disused shops
“Recent changes to planning laws permit a much more fluid interchange of commercial uses,” says Ellingworth, allowing disused shops to be turned into leisure facilities and flats. Clearly, this applies to the high street rather than shopping centres, on which Ellingworth’s advice to investors is “to run for the hills”. The share price of Hammerson, once a FTSE-100 constituent, has fallen by more than 99% since mid-2017; the group unwisely decided to focus on shopping centres several years ago.
For supermarkets with ample parking, the move to online shopping may allow for additional rentable buildings on surplus land. John Cahill of brokers Stifel describes the Supermarket Income Real Estate Investment Trust, or Reit (LSE: SUPR) as “one of the most mispriced shares in the sector, with the benefit of a portfolio of largely index-linked, long-dated leases to the major UK supermarkets”. Yet the shares yield a generous 5.4%.
This far exceeds the 3.4% yield of Tritax Big Box Reit (LSE: BBOX), a stockmarket darling. Its portfolio of large distribution centres next to major roads has proved indispensable to major online retailers scrambling to sign long-term leases with inflation-linked rents to facilitate the rapid delivery of goods. An 8% uplift in net asset value (NAV) to 172p-175p was announced in January, but Stifel targets a share price of only 160p against a current 186p.
Investors have, perhaps, become overenthusiastic about this corner of the industrial sector, which Ellingworth describes as “the ugly duckling of the market that has turned into a swan”. This is certainly true of Segro (LSE: SGRO), the £11.5bn giant of the property sector, once called Slough Estates. Now with an international spread of industrial property, its shares yield 2.2% and trade at a 26% premium to NAV. Its prospects certainly look good, but not good enough to justify the share price.
What next for the workplace?
The move to working from home should be a negative development for office property, but there are mitigating factors. Demand has been deferred, not shelved, according to brokers Numis, while the development pipeline is slim. “Offices won’t die,” says Ellingworth. “They’re simply too important for social interaction, collaboration and creativity.” Occupational density is likely to fall, thinks Numis, while occupational requirements means earlier obsolescence. According to Ellingworth, smaller offices with their own front doors in the West End will become more attractive than Canary Wharf’s large spaces and trading floors.
Supply is further constrained by the conversion since 2017 of at least 830,000 square metres of office space in London into 16,000 homes, a trend that could accelerate due to new legislation. There are reports of new rentals in central London that are 40% lower than in early 2020, but that is reflected in asset values and there should be a sharp rebound. Marcus Phayre-Mudge, manager of the TR Property Investment Trust favours firms “with firepower that can withstand any correction in prices and have the potential to improve their portfolios”...
To read the whole of this article, subscribe to MoneyWeek magazine
Subscribers can see the whole article in the digital edition available here