Many happy returns?

UK real estate investment trusts are coming up for their first birthday. Sonia Speedy asks whether they are bringing many happy returns

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The UK Reit market was ushered in when the UK property market was still riding high. It arrived to much fanfare, with Reits billed as a tax efficient and liquid way for investors to gain access to residential and commercial property investments.

“The hype was generated as a compensatory factor for the fact they had lost residential property investment within pensions,” suggests Derek Winsland, certified financial planner at Premier Wealth Management.

“I think that’s what fuelled a lot of the enthusiasm for Reits in the first place. People could see that it was one way they could invest in residential property, while at the same time using pension fund money to do so.”

But the timing of Reits’ introduction was nothing short of unfortunate. Soon after its launch a significant swing in investor sentiment away from commercial property began, later compounded by the effects of the now ubiquitous credit crunch. These events have taken their toll on the fledgling sector and over the past 12 months close to 35 per cent has been knocked off the share price of UK Reits, according to the FTSE/EPRA NAREIT UK Reit indices.

Anthony Shayle, UK managing director, Axa Real Estate Investment Managers, describes the numbers as “frightening”, saying some Reits are now trading at a 30 to 40 per cent discount to Net Asset Value (NAV), as oppose to a 15 to 20 per cent premium seen earlier in the year.

“It’s typical of what happens in the industry when there is a lot of hype around something,” says Dan Looney, investment liaison manager, Towry Law Investment Management. “Clients get in near the top unfortunately.”

Looney believes investors are now hinging their hopes on interest rates. “If you see lower interest rates and increased liquidity then Reits will probably stabilise. Obviously if rates go the other way then I reckon there will be more bad news and sentiment will come into play again and Reits will get hit even harder,” he says.

To date, 17 Reits exist in the UK, 16 of which are conversions from the listed real estate sector. Only one new Reit was created in 2007 – the Local Shopping Reit. Another two new offerings were proposed, but failed to launch, including a residential Reit from Invista and the Vector Hospitality Reit.

While anticipated future capital value decreases are generally regarded as being behind the yawning discount levels, Shayle suggests that as a rough rule of thumb, around 15 to 20 per cent of current discounts are attributable to these revaluations, while the other 80 per cent is down to market sentiment.

But despite the poor timing, the UK Reit market’s first year is still being hailed as a victory in many quarters. In his October Pre-Budget Report, Chancellor Alistair Darling described the introduction of Reits as a “marked success”.

Reits and quoted property group Reita project co-ordinator Dave Butler is another that believes Reits have seen victories, despite being overshadowed by movements in the commercial property market more generally.

“There is no doubt that anyone who invested in Reits on the first of January (2007) is probably feeling pretty disappointed now in terms of total returns,” he says.

“However, the legislation has been a significant success in that it has persuaded 75 per cent of the listed real estate sector to convert to Reit status. That’s a really solid start both from the Government’s perspective and from the market perspective,” Butler says.

Jorrit Arissen, global real estate securities portfolio manager, F&C Investments, also points out that Reits’ introduction has attracted many new investors to the UK market.

“What we hear from UK companies is that their shareholder base has changed dramatically, he says.

“They used to have a huge bias towards UK investors and that has come down significantly – it has more than halved, with the foreign shareholder proportion more than doubling.”

According to Butler, what has been less satisfactory however, is the lack of new companies coming to market. But he is not expecting to see many more until closer movement between share price and NAV is seen.

What has also been highlighted this year are areas of weakness within the Reit legislation. Butler says the institutional market is uncomfortable handling large scale residential investments due to issues such as the fact yields on residential property are typically much lower than on commercial property, making it difficult to pay out the 90 per cent of income required of a Reit.

“The second thing the Government needs to do is make it easier for new companies to come to market. At the present moment because you have to be listed on the main market stock exchange, which is an expensive business, it’s quite difficult to set up a brand new Reit proposition,” Butler says.

Shayle expresses similar sentiments. “If the Government wanted to really show its leadership in Europe in a very positive way, making the Reit legislation more functional and more flexible, would be a huge score,” he says.

In his pre-Budget report the Chancellor outlined that the Treasury was not currently minded to make changes to the existing Reit legislation, although it is to be kept under review. However, the Property Industry Alliance is soon to release a major report recommending changes, and it is hoped this will provide the Government with the information and impetus needed.

Regardless of the legislative tweaks desired, many in the industry believe the current blue period in the market is offering interesting opportunities.

Furthermore, research carried out in October, commissioned by Reita, found that 52 per cent of IFAs still planned to include Reits in their client portfolios, largely via collective vehicles. However, 34 per cent showed an increased preference for global funds and concern about UK investment.

Arissen says: “I believe that there is a little bit of over-reaction now in the market. There is so much pessimism in the press and I think this offers a good opportunity to enter.

“I guess that next year we will see some sort of rebound in the UK and people will start looking again at UK Reits as they are relatively cheap compared with those in the rest of the world,” he says.

Laurence Boyle, head of Assetmaster, Williams de Broe is taking an equally pragmatic approach.

He believes the three main factors behind the current market volatility all look likely to reverse.

This includes increases in long term interest rates, widening credit spreads due to the sub prime mortgage market fallout and on the capital side – compression of property yields.

As a result, Boyle suggests Reits are indeed still a property class worth consideration, particularly for those willing to take a contrarian view.

“The fact is you’ve got the interest rate cycle going in your favour and you can pick up a reasonable yield now. You are also buying things at a discount to true net worth, so even if that true net worth is valued down tomorrow, you’re still buying at a discount.”

As Shayle says: “If you talk about a 30 to 40 per cent discount on a company like Land Securities or British Land, I cannot believe that is realistic.”


Case study

Anna Sofat, director, AJS Wealth Management

“Direct investment isn’t always right for clients and Reits offer one alternative which is flexible and liquid…”

Anna Sofat, director of Kent-based AJS Wealth management,
is a strong advocate of property as an asset class and while taking a cautious approach at present, still sees a place for UK Real Estate Investment Trusts (Reits) within client portfolios.

“Direct investment isn’t always appropriate or right for clients and Reits offer one alternative, amongst others,” she says.

“I think they offer flexibility, they offer liquidity and although increasingly they’re behaving like other equity shares and you’ve got to take that into account, they are backed more by bricks and mortar and solid assets than your normal equity stock.”

With the large discounts currently on offer, Sofat suggests that despite the current market sentiment, buying opportunities are on offer in the UK Reit market.

“I think it’s actually not a bad time for investors to think about going in there, because sooner or later the more speculative investors will look at it. I think they’re already beginning to and if the rest of the market is jittery, they will fall back on more solid assets.”

Sofat says she likes to use UK property as a bedrock, diversifying client portfolios with global Reits. She favours the ING Global Real Estate fund, just over half of which is invested in Reits. She also uses a rule of thumb of putting no more than 5 per cent of a client’s portfolio into property shares. Whether 2008 brings recession or inflation, Sofat believes commercial property will hold up well.