Resilience is a significant factor for the sector has a whole. Although there is a large amount of security of income from the contracted income from the leases of standing investment properties held by the REITs, at any one time most of them are exposed to some developments of substantial refurbishments. If these do not find ready tenants, at viable rents, before or on completion, the empty properties can be a significant drain on capital and performance.
In addition, in down-turns or recessions, companies fail, causing a loss of rental income and generating vacant space at the worst time. Even outside these periods, business cost-cutting can mean tenants vacate properties as leases expire, which may then need refurbishment before re-lettings can be achieved.
The last few years have been a reasonable period for REITs: asset prices have generally risen and tenant demand has been good. This particularly applies in London and surrounding areas. The best performance has been achieved by the ‘prime properties’, the best quality buildings in the best locations, although even secondary property has performed well. While the 2008/9 recession was severe, the sector was, to a large extent saved by the falling cost of debt finance and the maintained demand, particularly from foreign buyers, for prime properties. Those REITS that held more secondary property – the smaller ones – or who had substantial development programmes, fared particularly badly. Some of those smaller ones barely survived, saved by the forbearance of the banks in some cases, which was a rather better outcome than previous recessions, when most of the smaller property companies failed.
Now, however, the direct markets are showing evidence of falling values. As is typical in a down-turn, the secondary property falls first and will eventually fall the most. Pricing in the REITs has anticipated that and most of the stocks are now at discounts to NAVs, but with their prices still trending down. REITs tend to lead the direct market because of their greater liquidity and transparency and, therefore, the falls in the values of the REITs – setting aside their gearing – is not likely to fall as much as the falls in the direct property market.
I believe that, with their falls in value over the last year or so, the larger REITs, with their more-prime property, have now stabilised but, in general, it may be too early to be taking a position in the sector. The direct property market moves slowly and has not properly differentiated its pricing between the different types of property. A general lack of transparency does not help. There will be a time in the future to gain exposure when the sector is demonstrating some stabilisation and starts to look forward to an eventual recovery.
Credit to Diana Patterson
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