In the first week of September, there were two major acquisitions in the real estate investment trust (Reit) sector. First, warehouse owner Segro paid £1.1 billion to acquire Tritax EuroBox, boosting its position in mainland Europe. On the same day, Starwood Funds agreed to buy the London-listed Balanced Commercial Property Trust for £674 million.
In both cases, a larger trust acquired a smaller business at a discount to its recorded underlying net asset value (NAV). In the case of Segro, its deal worked out at a premium of around 27% to EuroBox’s closing price before the latter company put itself up for sale, but the price implied a discount of 14% to the last reported NAV. Meanwhile, Starwood paid a premium of 21.5% for Balanced, but a discount of 9% to the company’s last reported NAV.
The Reit price?
Reit NAVs have always been subject to a degree of individual interpretation, and these two deals illustrate the current level of uncertainty in the market. Trust NAVs are calculated based on multiple factors, such as the estimated rental value of the property and similar transactions completed recently in the market. They are only ever a guide for investors and should never be interpreted as a hard and fast indication of underlying asset values. Ultimately, the price of the assets is limited by what any buyer is willing to pay.
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Shares in Reits have been under pressure since the beginning of the interest-rate hiking cycle. Investors have struggled to digest the impact higher interest rates will have on commercial property prices. As a result of the uncertainty, we’ve seen Reits across the market trade at high double-digit discounts to NAVs (as high as 30%-40% in some cases).
Discounts in the sector have fallen as the shock of higher rates has subsided, although the deals for Tritax and Balanced show there is still a disconnect in the market between estimated NAVs and the real world.
It illustrates why investors should not latch on to NAV values in the Reit sector. The best way to understand the value of a Reit portfolio is to look at the portfolio’s underlying rental income. If the trust has a collection of properties in a certain sector with high demand, such as warehouses, let on inflation-linked contracts, the quality of income from the portfolio will be both predictable and sustainable. Inflation-linked income is also less susceptible to volatile interest rates.
Tritax EuroBox is a classic example. This company has a high-quality portfolio, but its value has been determined by the quality of income produced by the portfolio rather than the value of the portfolio itself, as the deal with Segro illustrates.
Why investors should tread carefully
There are some attractive bargains in the Reit sector, and there will be further acquisitions over the coming months and years as smaller trusts merge with larger peers to reduce costs and appeal to a wider audience of investors. However, while there are opportunities out there, there are also landmines. Very small trusts with poor-quality portfolios are unlikely to be able to attract the attention of a larger group: buyers want quality, not quantity.
It is also unlikely that institutions will come in to drive up the price. In recent years, large institutions have shifted out of smaller investment trusts (both Reits and other trusts), and this transition is now mostly complete. Smaller retail investors are the only ones left at the table in the smaller section of the market, which is no bad thing, but it does mean they have to be more careful when selecting opportunities.
There are plenty of opportunities out there for investors in the Reit market, but discounts are likely to persist for some time. It would be sensible for investors to continue to focus on income rather than value in the sector for now.
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