Property Presenting Performance Potential

Despite the difficulties facing the UK economy, we are seeing four fundamental demographic and technological trends within the property sector: ageing population, urbanisation, 'generation rent' and digitalisation. With the maelstrom of mispricing, REITs benefitting from these trends are in a strong position to benefit from and may offer opportunities for the long term.

In particular, property across key sectors is presenting investors with opportunities to benefit from valuation gaps, especially within REITs.

The divergence between the continued strong property leasing fundamentals and the share price performance of REITs has created a significant valuation gap. UK REITs are trading at a discount to published net asset value (NAV) of approximately 38%¹.

The size of this valuation gap is a rare, but not unique, occurrence. During the past decade, there have been a number of occasions when REITs have traded at a 20%, or greater, discount to NAV.2 Most of these discounts occurred in periods of ‘black swan’ events, such as extreme political uncertainty (e.g. during the Brexit referendum) or a sharp economic slowdown (e.g. during Covid-19 pandemic).

In the 12 months following these occurrences, REITs generated an average total return of approximately 20% and, in many cases, returned to trading at a premium to NAV².

However, NAV discounts should not be viewed as an indiscriminate buy signal – security selection remains key, with REITs benefiting from the socio-economic trends mentioned above: ageing population and urbanisation, being strong performers.

For the former, Impact Healthcare REIT, which offers investors exposure to a diversified portfolio of UK healthcare real estate assets, in particular as the owner of high-quality care homes across the UK, is benefiting from the demographic tailwind of an ageing population. The company reported a 3.3% increase in NAV per share over the first half of the year, with management issuing positive guidance stating that, “we are well placed to deliver our 9% per annum medium term total accounting return target³.”

Impact recently sold non-core Attlee Care Home (68 beds in Wakefield) for £2.65 million, 4% above the latest book value as at 30 June 2022⁴.

In August, the group exchanged contracts to acquire two care homes in Kent for £14 million, plus acquisition costs, for a new tenant, Belmont Healthcare. The transactions are expected to enable the Group to deploy an initial £14 million of capital, plus transaction costs, followed by additional asset management and development opportunities; the initial annual rent has been agreed at £890,000, reflecting an accretive gross initial yield of 6.36%.

These acquisitions will be leased on Impact’s standard green leases, with fixed terms of 25 years and annual upward-only rent reviews linked to the Retail Price Index (RPI), with a floor of 2% per annum and a cap of 4% per annum, with commitments to a minimum annual expenditure by the tenant on the maintenance of the care homes⁵.

Within the urbanisation trend, Derwent London, the design-led London-focused office REIT, reported that leasing in the first half was strong, with new rents signed on average 9.3% above December 2021 estimated rental values. The REIT's total return for the period was 3.0%. Management issued upbeat guidance highlighting “good demand for our distinctive brand of high-quality offices, with short supply of prime space in our core locations.” In a world of rising volatility, the Company remains focused on investing in the best-in-class owners of high-quality real estate delivering reliable and growing dividends.

Derwent is employing a ‘flight to quality’, retaining large recently completed developments for longer, and selling buildings where it expects lower returns or where it does not believe they can be economically upgraded into the next generation of prime product. Proceeds are being reinvested into a pipeline of larger net zero schemes.

For example, Derwent sold Bush House, South West Wing WC2, a 103,700 sq ft freehold office building, to focus on delivering larger net zero carbon schemes at 25 Baker Street W1 and Network Building W1⁶.

Looking to the digitalisation theme, during August, Lok’nStore, the fast-growing self-storage company, reported that trading in the financial year just ended “remained excellent … with same-store self-storage revenue up 24.9%⁷.” With regards to asset values, the company highlighted that with “strong revenue growth and new stores opened during the year we expect our store values will rise to reflect this continued progress."

Propelled forward by structural socio-economic and technological changes, REITs benefiting from the four trends: ageing population, urbanisation, ‘generation rent’ and digitalisation, may offer a compelling opportunity for investment during this period of market turmoil.

Matt Norris will be hosting a third anniversary update webinar on Wednesday 23rd November at 10am, if you would like to register to listen, please click here.

Matthew Norris, Director of Real Estate Securities at Gravis, Director of Real Estate Securities at Gravis and Investment Adviser to the VT Gravis UK Listed Property (PAIF) Fund.

Capital at risk. Past performance is not necessarily indicative of future performance, the value of your investment may go down as well as up.

¹ EPRA Net Asset Value Report, September 2022

² Proprietary Gravis Advisory Ltd Research, Bloomberg

³  www.impactreit.uk/half-year-results-2022-and-dividend-declaration/

⁴  www.impactreit.uk/disposal-of-care-home-related-party-transaction/

⁵  www.impactreit.uk/acquisition-of-two-care-homes-and-new-tenant/

⁶  Interim-2022-Announcement-Final-Web.pdf (derwentlondon.com)

⁷  https://www.londonstockexchange.com/news-article/LOK/trading-update/15574432