Pop the champagne, hoist the main brace, rejoice, and be grateful! The real estate sector isn’t just up, by a whopping 6%, it’s also outperforming the All-Share Index.
It may have taken liberation day to prompt it, but ever grateful for small mercies. The equity market panic after the tariff war left UK real estate investment trusts (REITs) largely untouched to begin with. The impact, if any, was tangential with logistic owning companies suffering a minor hit but otherwise the defensive nature of the income streams and dividend certainty offered some degree of insulation, well at least until the tariff war escalated to numbers in three figures, and then everything had a secondary collapse. Given that this would all lead to a global recession, the thought process than turned to the prospect of interest rate cuts, which of course would be good news for real estate, even if tenants became more cautious, or at least that’s what the thinking became, I think!
While all this was going on, corporate activity in the sector remained active as the winnowing of the sector continued. Care REIT was taken over by the appropriately named US CareTrust REIT for $840m, Warehouse REIT is the subject of a bid from Blackstone for nearly £500m, and the corporate sponge that is LondonMetric is taking over Urban Logistics REIT for cash and shares in a deal worth £700m. The company has an outstanding record of taking over its fellow brethren; those that languish on deep discounts to their underlying worth, primarily due to their lack of scale and inability to access fresh capital to grow their business, because their shares sit on deep discounts, and are hence going nowhere slowly. Darwinism in REIT-land. I’ve always found it strange that it seems that only LondonMetric can take over other REITs and I applaud them for it. To some degree it’s because it has the currency in trading at a relatively narrow discount to NAV, so its paper is more highly rated and valuable than others, but equally that rating must be earned, and the “triple net” portfolio it runs just delivers compounding returns off long leases to high quality covenants in sectors offering fundamental tailwinds.
Having said that, inflation-linked leases may have had their moment. Prime, and I stress best in class only, assets are exhibiting rental growth now way in excess of inflation. It’s certainly true of Grade A London offices, where supply remains limited and demand somewhere between robust and very strong. It’s a landlord’s market for the moment and tenants with upcoming lease expiries seem more than prepared to commit to a pre-let with rents agreed often double digits in %age terms ahead of the valuer’s expectations, so no surprise there then. And then there’s prime retail, the big shopping destinations, not the West End thoroughfares. Even here rents are beginning to grow, albeit of significantly re-based levels but “rental tension” is beginning to emerge and in total returns, retail is the best performing asset class now. Strange, isn’t it? No one was going to work in an office ever again, and internet retailing was going to make physical shopping redundant. I read that HSBC which is moving from E14 to a better location in EC4 with a brand-new HQ by St. Paul’s and will soon occupy the building which is half the size of the !m sqft it occupied at The Wharf. Only problem is that it’s reported that it has seriously under-clubbed the amount of space it needs given that WFH was the rage when it signed for the new HQ and now a minimum three days a week in the office for staff might mean an extra 0.25m sqft is required somewhere.
Successful retailers are expanding, notably M&S, but JD Sports, Inditex, Next, Primark, and others. There are no new shopping centres, and these retailers will want to be, nay need to be, where footfall and spending power is greatest. Throw in the expansion of leisure operators in these shopping centres, many replacing former House of Fraser, Debenham, and John Lewis stores, and shopping centres are in danger of being renamed “retail and leisure destinations”, for that is what they are. I thought we were never going to go shopping again said the doomsayers a few years ago. Napoleon was right!
So, the two traditional asset classes of offices and retail which were the backbone of the sector for decades are both now in short supply and both exhibiting decent rental growth and the REITs that own these assets? 30- 40% discounts to net worth. Hmm, I wonder what could happen next.
This article was originally published in the Summer issue of The Property Chronicle.
