Real Estate Annual Review
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The year the rug was pulled out
2022 will be remembered as the year that the rug was pulled from under the property sector. Having benefitted from decades of low interest rates, which had fuelled debt-ladened deals and piqued the appetite of global investors looking for more than the paltry risk-free return on government bonds, the sector is witnessing a sharp valuation correction as central banks hike up rates. As investors retreated from the sector in the second half of the year, and property yields moved out to reflect the new risk premia, the share prices of property companies tanked, as shown in the graph to the right.
It remains to be seen whether the sell-off has been overdone, with some companies’ share price discounts to net asset value (NAV) moving to around 50%. Markets have calmed since the disastrous Truss-onomics experiment and inflation has seemingly peaked, which could see the pace of interest rate rises slow or rates even fall later this year. If discounts to NAV remain wide, this could trigger more merger and acquisition (M&A) activity this year in the sector, particularly if the outlook improves.
In the meantime, property companies have far healthier balance sheets than they did in the post-financial crisis period, and those invested in sectors with strong occupier fundamentals and have some degree of inflation protection through index-linked leases, are in a great place to regain their balance and establish a firm footing.
The property sector in 2022
Central banks’ move to monetary tightening to quell rising inflation in 2022 put to an end decades of low interest rates and one of the main drivers of valuation growth in the real estate sector. This was reflected in the total market capitalisation of London-listed property companies and real estate investment trusts (REITs), which fell by 31.8%, or £28.8bn, to £61.75bn.
A breakdown of the property sub-sectors, illustrated in Figures 1 and 2, show that companies focused on industrial and logistics saw the largest drop in share of market capitalisation over the year as values of low yielding assets were hit hardest.
The market capitalisations of the six companies focused on the industrial and logistics sector fell by an average of 44.3%. All sectors lost market value with the only property securities company, TR Property (which holds property stocks from across Europe), losing 38.2% in value. The nine London-listed companies focused on European assets was the next biggest loser with an average 37.6% decline. Figure 4 also shows that the market cap of the companies with diversified property portfolios fared better, with a fall of 22.4% compared to the property sector average drop of 31.8%, perhaps reflecting the defensive characteristics of a diversified portfolio.
The two student accommodation specialists also had a comparatively good year with an average share price fall of 16.2%. University applications are at record numbers among UK students, more than making up for fewer students from the EU following Brexit.
Fund performance data
Best performing property companies
There were just four companies with positive share price moves over 2022. Macau Property Opportunities, which owns property in Macau – the only city in China where gambling is legalised, led the way buoyed by the end of China’s zero-COVID policy. The group’s plan to sell its assets and return money to shareholders was boosted by the re-opening of the economy, however near-term progress may be hindered by a spike in cases.
Town Centre Securities had a good year, both in terms of NAV and share price performance.
This was largely due to the hugely profitable sale of an equity interest in a car parking app in July. The company then returned some cash to shareholders through a tender offer in August.
Logistics heavyweights SEGRO and Tritax Big Box REIT posted strong NAV growth during the year with valuations declines yet to be reported. For reasons mentioned earlier, both company’s share prices suffered heavily in anticipation of large portfolio valuation write downs, as shown in Figure 8 below.
All three of the listed specialist self-storage operators – Safestore, Big Yellow Group and Lok’n Store – had impressive years of NAV growth, as the sector continued to display resilient characteristics and demand-side pressures.
Worst performing property companies
One of the biggest stories in 2022 was the fall from grace of homeless accommodation provider Home REIT.
The company came under attack from short seller Viceroy Research in November with allegations including the artificial inflation of property values, conflicts of interest with property developers and rent arrears. Home REIT denies the allegations but has come under further pressure from investors, with one calling for the board to resign, and tenants withholding rents as promised refurbishments have yet to materialise. The company has grown exponentially since it launched in October 2020, successfully raising £350m at the end of 2021 and a further £263m this year, promoting it to the FTSE 250 index. Trading in its shares is currently suspended after it missed the four-month deadline for the publication of results due to the undertaking of an enhanced audit, which is required following the short seller attack.
As mentioned earlier, the logistics-focused property companies had a hard time in share price terms during 2022, with the two European players Tritax EuroBox and abrdn European Logistics Income joining its UK counterparts among the biggest share price fallers. Property yields in Europe hadn’t compressed to the same degree as in the UK, while financing rates were better on the continent, suggesting the outward yield shift (and valuation decline) would be less keenly felt in Europe than the UK. Nevertheless, their share prices were similarly affected.
Ground Rents Income Fund continued to be dogged by several legacy issues and ongoing headwinds relating to building safety and leasehold reform. Its board is now considering the future of the company.
Significant rating changes
Figures 11 and 12 show how share price premiums and discounts to NAV have moved over the course of the year.
There were few instances of discounts to NAV narrowing during 2022, with African-focused company Grit Real Estate top of the list with a 6.9 percentage point improvement. It had one of the largest NAV falls in 2022 (as shown in Figure 9), primarily due to the dilutive nature of a capital raise at the end of 2021, while its share price fell by just 7.0%. The company hopes to be able to provide investors with greater returns in the future with the proceeds of the raise used to acquire a controlling stake in a development company. Part of the proceeds were also used to lower its loan to value (LTV) ratio.
Retail specialists Capital & Regional, which owns secondary shopping centres, NewRiver REIT, the retail parks landlord, and big ticket mall owner Hammerson all feature in the top property companies share price rating moves over 2022. Retail assets have been less prone to the impact of rising interest rates having already suffered many years of yield expansion (and valuation declines) on their assets. All three finished the year strongly with Hammerson seeing a 33.0% share price growth in the fourth quarter, Capital & Regional 28.9% and NewRiver 4.0%.
Despite relatively decent share price performance in 2022, student digs landlord Empiric Student Property’s discount to NAV widened 9.5 percentage points to 28.5% as its NAV uplift of 10.9% was not replicated in its share price, which fell 2.1%.
Many of the names in the biggest rating deteriorations table have been mentioned previously. German business parks owner Sirius Real Estate suffered a collapse in its share price over the year, seeing its rating swing wildly. We also witnessed extreme re-ratings among the self-storage specialists.
Major corporate activity
Just £935m was raised by property companies in 2022, significantly less than the £3.8bn raised in 2021, reflecting the difficult investing climate caused by the higher interest rate environment and the ongoing war in Ukraine. All of the fundraises were completed in the first half of the year, when interest rates were at a lower level.
The majority of the £935m raised by property companies in 2022 was made in just three raises. Supermarket Income REIT led the way with a £300m substantially oversubscribed issue and a further £6.7m through a PrimaryBid offer. The total raised eclipses the original £175m target. The company deployed the proceeds into a pipeline of investment opportunities.
In happier days, Home REIT also smashed its fundraise target raising £263m – significantly above its initial target of £150m – before its woes started to stack up.
LXI REIT raised £250m in another substantially oversubscribed issue. The group quickly deployed the proceeds into a pipeline of long-income investments.
Among the other fundraises during the year were:
- £62.3m raised by Impact Healthcare REIT in two placings;
- abrdn European Logistics Income’s £38m (€45.6m) placing; and
- Residential Secure Income raising of £15m.
Mergers and acquisitions
Shareholders of both Shaftesbury and Capital & Counties Properties approved a £3.5bn all-share merger of the two companies to create a REIT, which would be called Shaftesbury Capital Plc, focused on the West End of London with a £5bn portfolio across Covent Garden, Carnaby, Chinatown and Soho. The merger is still awaiting Competition and Markets Authority approval and is expected to complete in the first quarter of this year.
In July, long-income specialists LXI REIT and Secure Income REIT merged creating a combined company with a portfolio worth £3.9bn and net assets of £2.8bn. Under the terms of the merger, each Secure Income shareholder received 3.32 new LXI shares per one Secure Income share.
In March, Hibernia REIT agreed a deal with Brookfield on the sale of the business for around €1.089bn. The offer price represented a 35.6% premium to its share price and a 7.6% discount to NAV.
McKay Securities was acquired by Workspace Group in May. The £272m acquisition allowed Workspace to extend its serviced office platform to locations in the South East outside its core London focus.
In February, Yew Grove REIT was acquired by Slate Office Ireland Investment Limited, an indirect wholly-owned subsidiary of North American real estate investment trust Slate Office REIT, for €177.4m.
Other major corporate activity
The proposed initial public offering of two new REITs – GCP Co-Living REIT and Independent Living REIT – were shelved during the year. Both were the victim of unfortunate timing. GCP Co-Living had been looking to raise £300m and invest in the fledgling co-living residential sector but the marketing period was scuppered by Russia’s invasion of Ukraine. Independent Living’s planned £150m IPO was canned due to the market turmoil following the mini-budget at the end of September.
Raven Property Group, the owner of warehouses in Russia, de-listed its shares on the London Stock Exchange after the war in Ukraine and subsequent sanctions on Russia. It sold its Russian business to Prestino Investments Ltd, which is owned and controlled by Raven’s Russian management team. Equity holders in Raven were wiped out entirely, while Raven retained an economic interest in the company via existing unsecured loans of £41m and Rub1.1bn and non-voting preference shares of £678m.
The board of Ground Rents Income Fund is considering the future of the company after several legacy issues and continuing headwinds relating to building safety and leasehold reform impacts performance. The board is required to table a proposal for shareholders to vote on a resolution for a voluntary wind-up and subsequent liquidation of the company at a general meeting to be held no later than 13 August 2023. The vote is structured in such a way that if any single shareholder votes for a wind-up, the vote passes. If the wind-up resolution is not passed, then the process is to be repeated every five years.
A number of companies changed their name during the year. Custodian REIT changed its name to Custodian Property Income REIT Plc. Its ticker (CREI) remains unchanged.
BMO Commercial Property Trust and BMO Real Estate Investments both changed their name, to Balanced Commercial Property Trust and CT Property Trust respectively, following the acquisition of BMO by Columbia Threadneedle. CT Property Trust’s new ticker is CTPT, while Balanced Commercial Property Trust remains BCPT.
Standard Life Investments Property Income Trust also changed its name – to abrdn Property Income Trust Limited, with a new ticker of API.
Major news stories
- Home REIT was the subject of a short-seller attack that alleged that many of its tenants were struggling financially and malpractice within the company. Home REIT strongly rebuffed the claims as baseless and misleading.
- Land Securities sold its 21 Moorfields office development in the City of London, which is pre-let to Deutsche Bank, for £809m and a 4.7% net initial yield. The price represents a 9% discount to the March 2022 value, but crystallises a development profit of £145m, representing 25% profit on cost.
- British Land agreed a deal to sell a 75% stake in its Paddington Central assets to GIC for £694m, representing a 1% discount to September 2021 book value and a net initial yield of 4.5%.
- LXI REIT renegotiated the leases of 122 Travelodge hotels, extending the weighted average lease length by a further nine years (from 19.5 years to 28.5 years). In return for the nine-year extensions, the company has inserted caps and collars on the annual rent reviews. Previously, the rent increased annually at RPI, but has been converted to CPI+0.5% with a cap (maximum uplift) of 4% and a collar (minimum uplift) of 1%.
- Great Portland Estates secured its largest ever letting – the 321,100 sq ft pre-let of its office development, 2 Aldermanbury Square, EC2, to international law firm Clifford Chance LLP.
- Derwent London exchanged contracts to acquire the Moorfields Eye Hospital and the UCL Institute of Ophthalmology, for £239m. The site is being sold by Moorfields Eye Hospital NHS Foundation Trust and UCL and is subject to final Treasury approval, which is expected by the end of 2022. Derwent plans to redevelop the 2.5-acre site into a 750,000 sq ft campus.
- Helical sold its TikTok-let Farringdon office building Kaleidoscope to Chinachem Group for £158.5m, at a 4.8% net initial yield. It let the 88,580 sq ft office to TikTok in March 2021 on a 15-year lease at £7.6m a year.
- Life Science REIT completed the acquisition of Oxford Technology Park, a 20-acre science and technology park, for £120.3m, meaning it has now fully deployed the proceeds from its IPO in November 2021.
- Student accommodation investor Unite Students acquired a build-to-rent property in Stratford, east London, for £71m as it looks to branch out into the residential sector.
- UK Commercial Property REIT acquired a hotel development site in Leeds for £62.7m. The group will fund the development of the 305-room hotel, which is scheduled to complete in 2024 and will have a 25-year franchise agreement in place with Hyatt Hotels. The hotel will be operated under a lease by Interstate Hotels & Resorts, with UKCM’s rental income based on the income generated from the operation of the hotel.
Selected QuotedData views
Outlook for 2023
Here are a few recent comments from managers and directors on how events may unfold in 2023, drawn from our latest real estate roundup.
Robert Orr, chairman of Tritax EuroBox:
“The knock-on impact of rising bond yields and debt costs, together with the increased likelihood of European economies experiencing a period of slower growth, has not yet been fully transmitted into real estate markets, with the scale and duration of adjustments to pricing and growth still uncertain. We believe the structural tailwinds positively impacting the European logistics sector, particularly the growth of internet retail, remain in place and other demand drivers such as the need for supply-chain resilience and buildings that support ESG objectives, will continue to create additional sources of demand. Low vacancy rates and constrained supply of land also serve to underpin occupational market fundamentals.”
Calum Bruce, manager of Ediston Property Investment Company:
“Reductions in disposable income could affect the retail market, including retail warehousing. Discretionary spending and the purchasing of ‘big-ticket’ items will be particularly affected. If retailers are impacted, there is an increased likelihood of them using Company Voluntary Arrangements (CVAs) and other insolvency processes to reduce costs. Despite the more measured short-term outlook, the fundamentals of the retail warehouse sector remain robust. Supply of available space is low, tenant demand is holding up, occupiers are still doing deals and we continue to identify and complete asset management transactions that secure income. We expect the retail warehouse sector to be the most resilient and flexible part of the retail market, which can adapt to the changing needs of tenants and the integration of their omnichannel strategies.”
David Hunter, chairman of Custodian Property Income REIT:
“We expect to see medium term acquisition opportunities as increasing debt costs drive market pricing for new investments closer to our income return requirements. We continue to view income as the key stable component of property returns. In these circumstances we expect investment market sentiment to transition from the relative volatility of single sector investing to a more defensive, diversified, income focused strategy.”
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