Should you buy real estate investment trusts at a discount?
Real estate investment trusts are out of favour, but could this be a good opportunity to buy at a discount?
- Property sector is suffering due to rising interest rates and weakened demand
- Reits are trading at huge discounts to net asset value due to sharp share falls
- Could it be a good time to buy Reits on the cheap?
The property sector suffered a blow in 2022, with commercial assets in particular taking a real hit.
It has meant companies in the sector have seen substantial falls in their share prices, and rising interest rates paired with the banking saga last month have done little to slow the decline.
Reits – real estate investment trusts – have seen their share prices plummet in recent months due to the economic backdrop and the fallout of the Home Reit saga, leaving them to trade at huge discounts.
With higher dividend yields, and a usually stable dividend income, has the Reit sell-off been overdone?
![The property sector is suffering due to the impact of interest rates and weakening demand](https://i.dailymail.co.uk/1s/2023/04/30/22/70298939-12020659-The_property_sector_is_suffering_due_to_the_impact_of_interest_r-a-4_1682888546585.jpg)
The property sector is suffering due to the impact of interest rates and weakening demand
Why has there been a Reit sell-off?
There are more than 40 Reits listed on the London Stock Exchange, with some offering more general exposure to property while others specialise in one or two segments.
Given returns from property are strongly correlated with economic growth, the sector has struggled as the impact of higher interest rates filters through to valuations.
The fallout from the collapse of Silicon Valley Bank last month also raised fears of possible loan defaults in the commercial property sector.
Numis analyst Andrew Rees said: ‘Inflation is proving to be sticker than the market perceives, so although share prices [of Reits] have generally strengthened in April following weakness induced by further concerns over accessibility of credit amid the SVB/wider banking crisis in March, we believe it will likely require meaningful declines in the inflation rate for the sector share prices to re-rate significantly.’
The Reit sell-off this year has been indiscriminate. While logistics and warehousing have faced more headwinds as companies cut back on space, the entire sector has suffered.
The FTSE EPRA Nareit UK index, which tracks the performance of real estate companies and Reits listed on the London Stock Exchange, dipped 8 per cent in March. This compares to a 2.8 per cent fall for the FTSE All-Share. It is currently down 30 per cent over the year.
While the economic backdrop has not helped the sector as a whole, the impact of the Home Reit saga has done little to help.
Social housing specialists like Triple Point Social Housing and Civitas Social Housing have been stung particularly badly. They are currently trading at a 62 per cent and 52 per cent discount to net asset value, respectively.
However they will be hoping that their track record of stable income and high collection rates will give investors some confidence.
Andrew Dawber, group director of Civitas, maintains that, given limited NHS beds and an ageing population, ‘demand demographics are very strong’.
As investors question the lease model used by social housing Reits, other specialists have also suffered.
Life Science Reit, which invests in biotech companies in the ‘Golden Triangle’ of Oxford, Cambridge and London, is currently trading at a 25 per cent discount.
Simon Farnsworth, managing director of Life Science Reit’s investment adviser Ironstone, thinks life sciences is largely insulated from other headwinds.
‘It’s not massively susceptible to consumer spending or house prices. It’s not even hugely susceptible to interest rates because a lot of businesses are not geared.
‘So, we actually see it as a really natural hedge against other occupier bases that are perhaps a little more vulnerable to some of the more widespread macroeconomic issues that are out there at the moment.’
He added: ‘I think what has happened is the real estate market has actually reacted much more quickly this time around in terms of down value in real estate. It’s been quite short and sharp. We’re seeing it stabilise quite quickly. And I think people have got to grips with where the underlying value of the real estate is now, and I think that’s really important.’
Do Reits represent value?
While investment trusts as a whole have been trading at a discount in recent months, those in the property sector have had among the widest.
Stifel’s John Cahill said the current share prices ‘present some pockets of deep value’ given the sector’s asset-backed returns.
Under the Reit regime, three quarters of the company’s assets must be properties that are available to rent, and 75 per cent of the profits must come from rental income.
Because of this, a lot of Reits sign long-term leases, meaning the income is usually quite reliable, and most of this is shared out in the form of dividend payments.
But a depressed share price and high dividend yield doesn’t necessarily mean it presents value.
![Life Science Reit leases buildings to biotech companies in the 'Golden Triangle' of the UK](https://i.dailymail.co.uk/1s/2023/04/30/22/70298943-12020659-Life_Science_Reit_leases_buildings_to_biotech_companies_in_the_G-a-5_1682888546738.jpg)
Life Science Reit leases buildings to biotech companies in the ‘Golden Triangle’ of the UK
Jason Hollands, managing director of Bestinvest said: ‘I am cautious towards property currently… the deep discounts on Reits are reflecting market expectations that the value of those assets are going to come under pressure given the challenging headwinds for the economy and ongoing risk of a recession as real incomes decline, borrowing costs nudge higher and the impact of higher taxes starts to be felt.
‘Those focused on the juicy discounts and, undoubtedly high dividend yields on Reits should also take a look at gearing levels too. This is a measure of the scale of borrowings versus the assets.
‘The average gearing of UK property companies is 21 per cent but some are much higher. Gearing is a source of risk and could creep even higher if the value of the assets on which the borrowing is secured against falls. If you are inclined to take a punt on a Reit, avoid those with high levels of gearing.’
The economic backdrop will play a huge role in how Reits will recover. If insolvencies start to rise, businesses will start to look at store and office closures, leaving Reits with rising vacancy rates.
Andrew Rees of Numis said: ‘We believe investors will be well served focusing on companies that have strong visibility of earnings that can underpin attractive and growing dividends. Positively, strong occupational dynamics across a number of sectors (industrials, private rented sector[PRS], retail warehousing) are providing a platform for many Reits to grow top-line rental income.
‘We therefore favour funds that have conservative balance sheets (lowly geared), without any near-term refinancing risk.’