The UK commercial property sector certainly seems out of favour as an asset class. Real estate investment trusts, or REITs, that have invested in retail and office space appear to be priced in bargain basement territory — many of them trading at discounts to their underlying assets of more than 20%.
Resilience
Landsec (LSE: LAND), the UK’s largest listed commercial property company, is no exception — its shares trade at 35% discount to its adjusted dilute net asset value of 1,403p per share. And that’s in spite of the underlying resilience of its investment portfolio and strong leasing activity in recent months.
Adjusted diluted earnings per share, a measure of underlying profitability, increased from 48.3p last year, to 53.1p, on the back of the completion of new developments and a reduction of interest costs. The company even managed a 14.7% boost to its full-year dividend to 44.2p, giving its shares a yield of 4.8%.
Valuation movement
Investors were perhaps more concerned about the 1% decline in its net asset value for the year. The value of its investment portfolio fell by 0.7%, giving Landsec a valuation deficit for the year of £91m.
However, the net asset value decline also reflected the refinancing of £1.5bn worth of legacy debts. This was a case of short-term pain for long-term gain, as it lowered its weighted average cost of debt to 2.6%, from 4.2% last year.
Retail sector
Also offering investment potential within the sector is Hammerson (LSE: HMSO). The retail-focused REIT, which recently dropped its plans to buy rival shopping centre owner Intu Properties (LSE: INTU), is reshaping its strategy in an attempt to unlock value for shareholders.
Hammerson’s bid to buy Intu failed as it was unable to garner significant shareholder support amid fears of the heightened risks of the proposed merger. Now, the company could itself be looking at further asset disposals as it seeks greater exposure to higher-growth segments of the retail market and assesses the potential for greater cash returns to shareholders.
It has so far announced plans to exit the retail park sector over the medium-term and initiated a £300m share buyback programme. With shares currently trading at a 37% discount to net asset value of 776p per share, there’s significant potential upside from a re-rating of its shares as the company repositions its property portfolio.
Intu
Unsurprisingly, Intu’s shares have fared even worse following the aborted takeover by Hammerson. Shares in the company trade at a 56% discount to net asset value of 362p per share, reflecting concerns about the group’s high leverage and falling property valuations.
In the six months of 2018, Intu took a massive £650m property revaluation hit, as the market value of its investment properties dropped from £10.5bn, to £9.8bn. Aside from the obvious impact to net asset value, which fell by 12% over the period — more worryingly, the valuation deficit also inflated its debt to assets ratio to 48.7%.
If property valuations continue to trend downwards, Intu, which already has an above-average financial gearing in the sector, could be forced to raise equity or cut dividends to prevent its loan-to-value ratio from exceeding 60%.
Intu’s shares are currently one of the highest-yielding in the REIT sector, with a yield of 8.8%.
