One of the worst performing sectors in 2022 was property as the cheap borrowing taps were turned off and an abrupt end of a decade of quantitative easing saw interest rates and market expectations jump above prime property yields. It sent the share prices of most real estate investment trusts (REITs) on a downward spiral as the market anticipated large valuation falls.
But has the market overcooked it and left REITs looking tantalisingly cheap, and could this trigger more consolidation in 2023?
The issue with property is that valuations are backward looking, with assets valued every six months (some companies’ portfolios are valued quarterly) making it pretty hard to decipher the impact on portfolio values in real time. The latest valuations we have are from companies that reported to the end of September 2022 (just a week after Kamikwasi).
These showed significant falls across the board, but the industrial and logistics sector was hardest hit – having seen prime investment yields fall to record lows of around 3% – 3.5% after years of strong investor demand. We await the end of December numbers but anticipate further falls across all sectors but with the other sectors and secondary stock catching up with industrial and logistics.
Interest rate expectations have eased significantly since the end of September, however, which has alleviated some repricing pressure on property values, but REITs are still trading on discounts to net asset value (NAV) last seen during the global financial crisis (GFC).
Cyclical downturns have traditionally precipitated consolidation and, with REIT share prices trading at GFC discounts, a rerun of the £35bn of take-private deals in the 2000s may be on the cards. There is certainly a lot of private equity dry powder waiting in the wings, with one real estate publication this week stating that buyout firms were readying an assault on London-listed property companies.
There has been £9bn of mergers and acquisitions (M&As) since 2019, with prices at NAV and, on average, 30% above share price, and such activity could kick off again. At the discounts that property companies are trading, we think most will be in the crosshairs. The sector specialists have tended to be the target of private equity firms – with Blackstone buying St Modwen and GCP Student Living in 2021 for £1.27bn and £969m respectively.
We could see some more mergers of the so-called generalist REITs, which have diversified portfolios but recently heavily skewed to industrial and logistics. Last year LXI REIT merged with Secure Income REIT to create a £2.8bn company, and on the smaller end Custodian Property Income REIT swallowed Drum Income Plus REIT. Most of these diversified trusts are small and have similar assets and portfolio weightings as well as investment strategies, so it would make sense for a coming together to create larger, more cost efficient REITs.
With private equity circling and large discounts prevailing, 2023 could be the year of consolidation in the property sector.
QD view – REIT consolidation on the cards in 2023