Real estate, alternative real assets and other diversions

Listed Real Estate is in remarkably good health The UK economy is either growing or capable of pumping out reliable income streams

The Fund Manager

The UK’s listed real estate sector was hard hit by the taper tantrums of 2015. It tried to recover but any hope of a return to the bull market conditions which prevailed from the lows of 2009 were snuffed out by Brexit. The sector hasn’t been the same since.

Certainly, that is what you would think if you looked at the Landsec share price. Five years ago it was 971p; today it is 980p, having celebrated the 2015 results along the way with a peak of no less than 1,453p. And Landsec is not alone. The British Land chart looks pretty similar albeit that the share price is 10% higher than it was five years ago.

Look at Landsec’s financial results and the picture is rather different: Net assets grew from £7.1bn in 2013 to £10.3bn which was rightly celebrated in 2015. Since then the number has drifted sideways – up slightly in 2016, down slightly in 2017 and, if forecasts are to be believed, up again to around £10.8bn in 2018. A billion pounds of debt has been repaid, the LTV has come down from just over 35% to almost 20% and the quality of the portfolio has been improved markedly with the sale of swathes of mid-tier retail and the redevelopment of much of the office portfolio, yet the shares trade at a 33% discount to the likely 2018 NAV.

Maybe this is because the shape of the portfolio remains broadly unchanged with 47% in London offices, 43% in retail (roughly a third of which is in London) and 10% in hotels and leisure.

Sentiment towards the London office sector was particularly hard hit in the wake of the Referendum. You only have to look at the Derwent London share price to see that: it fell 42% from the 2105 peak to the post Brexit low while LandSec was down a mere 31%. What is interesting is that the London companies, Derwent London, Great Portland, Workspace and Helical Bar never lost their nerve. They are not heavily exposed to the City and its presumed Brexit woes, they trusted in the tech sector, which remains vibrant and apparently immune to Brexit and kept on building and letting space. They have been rewarded with firm rents and their valuations have been supported by a continuing flow of international capital which seems to be able to look through any short term dislocation to the long term advantages of the UK in general, with its stable economy and robust legal system and London in particular with its unchallenged role as a World city. It has taken a while, but a steady flow of supportive letting and investment evidence and a more relaxed attitude to the risks inherent in Brexit is now bleeding into share prices. Derwent London, for instance, is up 36% from its Brexit low, having paid two special dividends along the way, and Workspace which is most exposed to the new economy is making post crisis highs, having comfortably broken clear of its 2015 levels. Given its 47% London office weighting some of this should be rubbing off on Landsec (and British Land).

While sentiment towards London offices is recovering, the same cannot be said for retail. Here attitudes are being set by investor perception of the retail sector where internet penetration is on a constantly rising trend and a steady stream of retailers which have failed to adapt are reaching a tipping point beyond which they are no longer viable, with House of Fraser the latest to contemplate a CVA. It is salutary to note that the stock market now believes that ASOS (market capitalisation £5bn) which according to Bloomberg is likely to make net profit of £78m in the coming year is more valuable than Marks & Spencer (£4.7bn) which makes five times as much money. Indeed on this measure it is rapidly catching up with Next (£7.3bn) which is forecast to make £576m and which derives half of its sales from the internet. Against this background it is hardly surprising that the stock market can’t get enough of the distribution sector while physical shops are almost universally shunned. Relative winners, like Hammerson, are tolerated but any suggestion that they might exploit their relative strength by acquiring good assets from weak holders is met with a stony stare. This is understandable, but disappointing because the economies of scale – in terms of access to debt, cost savings and, most importantly, the ability to engage with successful retailers like Apple across a continent wide or even global portfolio – are compelling. Like Landsec, the Hammerson share price is back to where it was five years ago while Intu has lost a third of its stock market value since then. While Landsec did the right thing in selling its weaker retail, in share price terms it is being punished for reinvesting into Bluewater and Oxford and perhaps for being sub-scale in a globalising sector.

Portfolio mix is part of the explanation but by no means all of it. Along with British Land, Landsec is  one of the few UK property companies to make it into the top tier globally. This matters because much of the capital invested in the sector is managed on a global basis and these stocks are consequently going to bear the brunt of any enthusiasm (or otherwise) for UK real estate. Post Brexit, there has not been a lot of love for the UK among this group of investors.

The Fund Manager

About Adrian Elwood

Adrian Elwood

Adrian Elwood has been researching and investing in the listed real estate sector for over thirty years. He was a member of the listed real estate team at Henderson Global Investors from 2004 to 2010. In September 2012 he established The Clerkenwell Matterhorn Fund, a Malta domiciled PIF with an absolute return mandate to invest in the sector.

Articles by Adrian Elwood

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