Continuing with our periodic series on REITs, we take another look at how the UK REITs have fared since the start of 2007.
Generally speaking, progress has been less than impressive but whether this is down to the new legal framework or general conditions in the UK real estate sector remains to be seen. The article ascribes the weakness, including substantial discounts to the new REITs’ net asset values, to the traditional priority given to asset appreciation over cash flow generation on the part of UK property companies.
UK commercial property prices rose steeply in the last few years and continued to rise through to May this year but the Bank of England has warned that this was not in line with rental incomes. Asset value appreciation looks likely to be more difficult to achieve from now on and, in particular, there is a lot of prestige office development in the pipeline in London due for completion around 2010. Commercial property bears were already reckoning the implications of the high ‘crane count’ in the City of London last year.
As of today, according to the REITA, the trade association for REITs and quoted property groups, there are 16 REITs open for business in the UK with the latest to join their ranks being Derwent Property and A & J Mucklow, who both changed to REIT status on 1st July. Most of these shares had not performed very well in the first of half of the year; Land Securities and Warner Estate showing falls of 12 and 10% respectively in the 6 months to 1st June. Having said that the performance of the whole sector on London Stock Exchange main market has been distinctly mediocre in that period.
St Modwen (still a property company) and Hammerson (one of the first batch of REITs in January) are two of the few companies to buck the trend with share price rises of 10 and 23% respectively. St Modwen’s business model of property development using its own resources (including its land bank and staff) preclude it from joining the ranks of the REITs. Hammerson produced an excellent investor’s crib sheet in the lead up to conversion.
Another property company that won’t be going down the road to REIT conversion is Capital & Regional which describes itself as a co-investing real estate asset manager working in tandem with property funds.
A number of pub/restaurant chains, including Punch Taverns, JD Wetherspoon, Enterprise Inns, Greene King and Mitchells & Butler have ruled out converting their properties into REITs. This may be partly over concerns about retaining operational control and partly lack of confidence about the performance of REITs. Greene King has opted to seek a joint venture partner for just over one third of its estate to form a op co/ prop co (operational company / Property company) entity . Further possible deterrents to creating a REIT are the requirement for all REITs to be converted from listed property companies and the 2% conversion charge on assets.
In the healthcare property sector, PHP announced its intention to convert to REIT status at the start of the year. Another specialist property business to convert was Big Yellow, the self-storage firm.
Roger Bootle, writing in Deloittes Real Estate Update a year ago (read pdf report here), focused on the possibility of property developers selling developments to REITs and speculated if this would be a way to improve the UK’s sluggish house-building industry. He also deals in some detail with issues relating to UK REITs holding foreign property, the possibilities for companies that owner-occupy their premises and compares REITs with Jersey Property Unit Trusts. Deloittes also highlights the relatively low dividends to interest payable ratio of 1 ¼ to 1 in the REIT regime. Writing on the day the Bank of England raised the base rate to 5.75%, interest rates seem bound to impact the gearing and scope for expansion on the part of UK REITs.