Land Securities and British Land dominate the UK commercial property scene. But can you choose between them?
The FTSE 100's Real Estate Investment Trusts (REITs) were on a tear this morning, with both Land Securities (LSE: LAND) and British Land (LSE: BLND) up over 5% at one point.
A fluke; this article was commissioned a week ago. Such is the value of snooping around beaten down sectors -- and few were more trashed than commercial property.
2007 saw new laws enabling UK property companies to convert to REIT status, giving them certain tax advantages. REIT hype on the back of several years of double digit returns encouraged billions in new money into the sector, inflating prices and depressing yields.
Commercial property always looked like a bubble, but the credit crunch that popped it was more wrecking ball than pin. Easy money evaporated, over-leveraged players were forced to sell assets and funds did too to meet redemptions from panicking investors. Voids increased, and rental income began to drop as the recession bit.
Originally touted as buys for income seekers, REITs cut their dividends and undertook rights as property prices plunged.
Share fight!
You don't need to look much further than leading UK REITs Land Securities and British Land to see the carnage:
| | 3 months | 1 year | 5 years | 10 years |
|---|
| British Land | +34% | -27% | -24% | +2% |
| Land Securities | +35% | -50% | -41% | -22% |
Needless to say, without the recent rally those long-term returns would be even worse.
In retrospect, REIT legislation came at exactly the wrong time. Commercial property was already over-valued, but the REIT conversion story gave the investment industry a new line to tout to investors who might otherwise have spurned the low yields.
As REIT legislation came in, British Land shares peaked at £12.97 while Land Securities hit £20.54. By the lows of March 2009, both shares had fallen over 80%.
Why buy British Land?
Still, that was then and this is now. Bottom fishers have been sniffing around commercial property for months, making this week's rumour of a £6 a share bid for British Land seem credible.
Buying on takeover gossip is a gamble though -- potential investors are better seeing what they will get for their money today, not what a bidder might pay tomorrow.
According to its March results, British Land has Net Assets of 398p per share, so at 515p the shares are trading at a 30% premium.
But there's debt, too: including its share from joint ventures, British Land owes £5,649 million, well over its current £4.4 billion market capitalisation.
Though unwelcome, negative equity isn't fatal for property companies any more than private owners, provided repayments are met and banking covenants aren't breached. British Land's management even argues its debt structure adds to its Net Asset Value, suggesting 508p is a realistic figure in March.
Certainly, not everyone can borrow billions to exploit the difference between loan repayments and rent, and income isn't half as bad as the capital picture -- underlying pre-tax profits fell from £284 million to £268 million in the past 12 months.
The pain comes from asset writedowns, which caused a whopping £3.9 billion loss for the year.
British Land has bolstered its balance sheet, however, raising £740 million from investors at a tough time, halving its stake in Meadowhall (that took debt down by £1 billion) and selling another landmark building for £400 million.
The company is set to pay a reduced dividend of 26p a share, representing a 5% yield. With 96% of its space let for an average of 13 years, its income looks fairly secure -- provided those tenants don't go bust.
Still, the dividend is only just covered on current forecasts.
How safe is Land Securities?
Land Securities has also shored up its balance sheet with a rights issue and asset sales.
The capital raising -- Land Securities' first for 29 years -- raised £756 million, while the £1 billion worth of assets it offloaded included its Trillium outsourcing arm, sold for £750 million (including debt).
That's much less than the £1 billion Land Securities thought it could get for Trillium when it proposed dividing itself into three companies during the boom. Any notion of splitting the two remaining divisions -- Retail and London -- have been shelved.
Interestingly, Land Securities said in its May 2009 annual results that property disposals achieved prices 18.5% lower than March 2008's valuations. That's bad, but less bad than the worst doomsaying and Land Securities' own 33% estimate. If the economic picture clears, things could get better, fast.
At 656p, Land Securities trades at around the basic NAV per share of 639p cited in its finals (though more recent sales suggest that NAV may have declined by another 2.5% or so). The company has aggressively reduced its debt, but it was still carrying £3.9 billion in debt as of March.
As with British Land, huge writedowns resulted in a loss of £4.7 billion. And again, the underlying earnings picture isn't (yet) anything like so bleak, though (it actually claims a slight rise in revenue profit due to lower interest payments).
Shareholders are promised a much-reduced 28p per share in dividends for the year. This 4.3% yield looks slightly better covered than British Land's payout, though earnings are currently a bit of a lottery with both companies.
Incidentally, Land Securities has a modest pension surplus -- rare as hen's teeth these days!
Barely a party wall between them
It's hard choosing between Land Securities and British Land. Both companies are a similar size, carry similar debt, have undertaken similar-sized rights issues, offer thinly-covered yields of 4-5% and expose investors to a broad portfolio of British property assets.
Picking one though, I'd choose Land Securities -- it looks slightly cheaper compared to assets, its debt a smidgeon more manageable, and I like its portfolio of prime London property.
Predators apparently prefer British Land and have bid up its price accordingly, so who knows?
Personally, I invest in commercial property via the iShares UK Property ETF (LSE: IUKP). This tracks a basket of UK REITS, including a big slug of British Land and Land Securities.
Property is for the long term
British Land is up over 60% since its March lows. Will the gains continue? Investment bank Nomura warned recently that underlying asset revaluations won't have kept up with resurgent REIT share prices.
That's undoubtedly true -- the flipside is the declines in both NAVs and REIT prices were likely overdone, too.
I think both the REITs I've discussed will repay money trickled in now with years of rising dividends and gradual capital gains. Act like an old-fashioned landlord -- buy property cheap for income, and then sit on it.
More from Owain Bennallack:
