Property Week - REIT Sector Ripe for Consolidation11 Nov 2022 16:59
It was mini-Budget remorse last week when chancellor Jeremy Hunt pressed Ctrl+Alt+Del on Trussonomics, and 10-year gilts fell back to 4%, from a recent 4.5% peak.
This is alleviating some repricing pressure on property values, but REITs are trading at discounts to net asset value (NAV) last seen during the global financial crisis (GFC), and the lack of REIT executives buying their own stock doesn’t add confidence.
In September, the narrative was between Truss the radical tax-cutter and Sunak the cautious inflation fighter, but on fiscal matters they weren’t far apart. Sunak derided “fairy-tale economics” of unfunded tax cuts with soaring inflation, but promised tax cuts once inflation had been “gripped”. There was an element of timing and tone.
Rishinomics showed complacency about recession by raising taxes. The OECD warned against the UK’s “contractionary” position and urged “slowing fiscal consolidation to support growth”. Until the OBR reports on 31 October, the downgrading by Moody’s of the UK’s economic outlook to negative is likely to cast a pall over gilt yields and REITs.
The cheap borrowing taps have certainly been turned off and REITs face challenges in beating costs of capital. Cyclical downturns precipitate consolidation in capital-intensive industries and REITs need to reduce their costs, including by shrinking boards, with fewer COOs and CIOs.
Five-year interest rates have risen from 1% to 4%, lending margins from 100bps to 200bps and equity from 5% to 10%, so the squeeze is on and spread traders have been priced out of the market. Meanwhile, Landsec and British Land are 40% smaller by equity market value after a decade of cheap borrowing, which is the raw material of these firms.
REIT shares trading at GFC discounts could invite a rerun of the ÂŁ35bn of asset privatisations in the noughties. Disclosure is better, but still not adequate, so mergers and acquisitions (M&As) must be agreed, with only two successful hostile bids in the past 30 years: Slough Estates expensively acquired Bilton in 1998; and Hammerson unwisely outbid a management buyout for Grantchester in 2002.
There has been ÂŁ9bn of M&As since 2019, with cash offers pitched at NAV and, on average, 30% above share price, and such activity could kick off again. The sector is overpopulated, with a proliferation of spread trader REITs, and is overdue for winnowing. Too many REITs are controlling too many assets and those with the lowest cost of capital have the capacity to cut rents in a downturn, invest to combat depreciation, green-up their portfolios and afford the best managerial talent.
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