Royal Bank of Canada believes the current lack of a traditional cycle and big structural changes are creating significant complexity for UK commercial real estate landlords.
Within that context, it believes UK REITs in our coverage benefit from relatively strong starting points and has issued outperform ratings for Landsec and Tritax and sector perform ratings for British Land, Hammerson and SEGRO.
In its assessment is points to:
Less cyclical markets – “UK rents generally at or close to their highs and property yields/interest rates at their lows make for an unattractive growth outlook in our view, all else being equal. We believe UK CRE markets have become less cyclical due to less development and debt, but have not lost their cyclicality. A significant pause in tenant demand could be the trigger, something made more likely by the current macro environment in our view.”
Big structural changes – “Numerous large structural trends, such as urbanisation, globalisation and use of technology are not new and evidence of their impact on UK CRE rents is growing. However, the risks for landlords in adjusting strategies to satisfy increasingly demanding tenants are still significant in our view. Tailwinds make it much easier in industrial real estate; we forecast up to 30% market rent growth over five years. The opposite is the case for retail, where we expect market rents for most properties to decline significantly.”
Various REIT responses – “We believe the portfolios of these six UK REITs place well within their respective markets. Their financial gearing is generally low, but they still plan disposals, which should further reduce their exposures to the UK outside London. Some REITs remain more focused on timing the cycle, but all appear to be shifting their strategies to some degree to become more customer and income focused. We believe a shift from cyclical financial investor to more of an operator plays to the REITs’ strengths, but is likely to lead to additional costs and operational risk.”
Discounted valuations – “Share price under-performance since late 2015 stands out versus the resilience of the REITs’ underlying CRE markets. Discounts to historical average multiples implied by the REITs’ current share prices offer limited upside overall in our view given the weak growth prospects we forecast and/or additional risks. A wide range in multiples between stocks appears to reflect exposure to UK retail (excluding central London) and/or financial gearing. Similarly, multiples generally appear well correlated with our growth forecasts.”
A range of ratings – “We initiate coverage with two Outperform ratings (Landsec and Tritax), one underperform rating (Derwent) and three sector perform ratings (British Land, Hammerson and SEGRO). Our most non-consensual rating is on Landsec; its current 6.8% earnings yield is attractive even before taking into account its very low risk profile in our view.
“For Tritax (5.0%), it is its strong growth and low risk that are appealing rather than a discounted multiple. In contrast, we believe Derwent’s 15% NAV discount fails to reflect the gradual London office market rent declines we forecast.”
