VALUE INVESTING
Value Guide To Property

By Stephen Bland (TMFPyad)
March 21, 2003

Continuing my look at market sectors from a value viewpoint, I'm giving property a go this week, or to give it the American description used these days, real estate. (Beginners should note this sector does not usually include those companies whose business is primarily the development and sale of residential property; those are listed under the construction sector.) The real estate sector is comprised, in most cases, of shares whose main business is the letting of commercial property.

There are presently sixteen companies in the real estate sector of the FTSE 350 index, which I list in order of market capitalisation. Due to the way the database I use is constructed, price to tangible book value (P/TBV) and gearing figures are based on the last annual accounts and may consequently be somewhat out of date. Yields are based on consensus forecasts, though.

                                                      Net
                                   Cap£b    P/TBV   gearing%   Yield%

Land Securities (LSE: LAND)         3.9      0.67      32        5.2
British Land (LSE: BLND             2.0      0.52      94        3.5
Liberty International (LSE: LII)    1.8      0.68      68        4.3
Slough Estates (LSE: SLOU)          1.2      0.53      57        5.1
Hammerson (LSE: HMSO)               1.2      0.59      65        4.0
Canary Wharf (LSE: CWG)             1.0      0.58     141        0.0
Chelsfield (LSE: CLF)               0.6      0.54      64        2.6
Brixton (LSE: BXTN)                 0.5      0.57      82        5.9
Great Portland (LSE: GPOR)          0.4      0.62      48        4.9
Pillar Property (LSE: PLL)          0.4      0.75      42        2.5
London Merchant (LSE: LMSO)         0.3      0.36      25        6.4
Quintain Estates (LSE: QED)         0.3      0.73      59        4.3
Grainger Trust (LSE: GRI)           0.2      1.98     184        1.4
Derwent Valley (LSE: DWV)           0.2      0.43      51        2.7
Shaftesbury (LSE: SHB)              0.2      0.57      80        2.5
Minerva (LSE: MNR)                  0.2      0.39      81        2.7

Value hunters in the sector need to be aware of three important differences between evaluating property shares and the general market. Firstly, price to earnings (P/E) ratios are not important; secondly, net asset value is the primary valuation tool used by investors and nearly all property shares trade below this level; thirdly, nearly all properties will have net gearing, not net cash.

As I said, property shares are judged upon, and traditionally trade below, book value, somewhat like investment trusts. This discount varies according to the prevailing financial climate, tending to narrow when the outlook for commercial property values appears strong and vice versa.

It follows that it is in the degree of discount to book that value is to be found. The current average discount for the shares in my list is about 43%, excluding the special case of Grainger Trust, which is more of a development company than a letting operation. So, any property share displaying a greater figure than this, i.e. a P/TBV of less than 0.57, is in consequence showing value by the standards of the sector.

The other major value indicator in my view for the sector is gearing. Clearly, the lower the borrowings, the safer the share is if hard times occur. In a major recession, some property shares tend to go bust and it is those with the largest debts that are more likely to do so, the more conservative ones being the survivors. Value investors look first for safety but gearing tends to be on the high side as a norm in this sector compared to the market generally. Illustrating this, the average of my list is 73% so any figure under this is a value feature by sector standards.

Yield here is a similar indicator to value generally, with those shares in the sector perceived by the market to be very successful at increasing their net assets rapidly having the lowest yields, with the opposite applying too.

So which companies appear to be value buys?

Well, looking at the three lowest P/TBVs we have, in increasing order, London Merchant, Minerva and Derwent Valley.

The three lowest gearings in that order are London Merchant, Land Securities and Pillar.

The three highest yields are London Merchant, Brixton and Land Securities.

London Merchant therefore appears in all three cases and Land Securities, the biggest of them all by far, in two. London Merchant is something of a special case, in fancying itself as a small cap and tech share investor as well as a property player. In the tech boom a few years ago, it was driven up way out of all normal property share valuations for this reason and of course fell right back in the tech bust, maybe too far.

These sorts of trawls are always just a first indication, a filter to sniff out likely value candidates, yet it is crucial that potential investors have a look at the accounts and any more up-to-date information not shown in them. With property, there is property and then again, there is property. For example, some company portfolios might consist essentially of a lot of office buildings in city centres, perhaps largely in London. Others may comprise largely of retail shopping malls or business and manufacturing areas, maybe only in certain regions, and so on. You need to be able to judge the quality of the companies' estates but as always with value, try not to be swayed by the prevailing beliefs of the market commentators and look for something where you think the consensus may have got it wrong.

Major property crashes can occasionally occur and, like stock market crashes, are an exceptionally good time to find bargains using the above techniques, provided you have really lengthy patience. However, we are not at present in one of those periods though if you expect one, then now would be the wrong time to buy of course. Discounts, though, as a result of the bear market, are pretty high and thus attractive superficially, almost as if the market is expecting property values to fall.