Low demand and cost hit real estate investment trusts

Real estate investment trusts (Reits) were launched in Britain just over a year ago – a time when investors were still celebrating double-digit property returns.

A year on and the story could not be more different, with investor sentiment having nosedived and British property companies trading at 30-40% discounts, rather than 15-20% premiums.

Whereas at the beginning of 2007 British investors were piling money into commercial property, the end of the year saw net outflows from property funds, according to the Investment Management Association (IMA). Over the last year the average return of property funds listed by Morningstar is negative and the FTSE/Epra Nareit UK Reit index fell sharply.

Nonetheless, some say the UK Reits story is one of success, it was the timing of their introduction that was unfortunate. The benefit of converting to Reits for both property companies and investors is the elimination of double taxation. As a Reit the only tax payable is at the investor level, rather than at a corporate level. This put Reits on a level playing field with direct property investment. For this reason more than 75% of Britain’s listed property companies converted to Reits status in 2007.

There are now 18 British Reit companies. This time last year there were nine. Although most property companies that existed before the introduction of British Reits legislation have converted, many are disappointed with the lack of new property companies coming to market.

Only two new companies were created in 2007. One was the Local Shopping Reit, while the other was Rugby Estate. Others attempted to list but failed to do so, according to Dave Butler, programme co-ordinator for Reita, the Reits and quoted property group. He blames a lack of demand in the market and the expense of listing.

Butler says he does not expect many more property companies to list until share prices move closer to net asset values (NAVs).

“There’s not much point in coming to market if you are going to sell [shares] for less than they’re worth,” he explains. “We’ve seen a significant decline in value of property shares. They are trading at 30-40% discounts to NAV. There isn’t enough demand around to keep prices up.”

Butler says another deterrent for new property companies is the expense of listing. “You have to be main market listed to be a Reit,” he says. “There are costs associated with that. We’d like to see some easing on those rules. But you need the market to be positive.”

However, there are signs the market is becoming more positive. Schroders last month called the bottom of the property share market and Anthony Bolton is going back into it, according to Butler. The issue is how soon property shares will rebound. The bulls estimate this will happen within the first half of this year. However, the more bearish predict it will not be until the end of the year or 2009 before prices turn around.

Jorrit Arisse, portfolio manager Europe, F&C Global Real Estate Securities fund, is increasing his exposure to the British Reits market. In the past two weeks he has trimmed other regional allocations and increased his exposure to Britain by 3%. His current allocation stands at 13%.

“The UK looks relatively cheap at the moment,” says Arisse. “Reits in the UK are trading at a 33% discount. This means investors are anticipating the NAV to fall and have factored in a 21% drop in capital values. The discount to NAV is larger purely because of leverage. The question is, is that reasonable?”

Ian Shipway, investment director at Thinc Group, agrees the discounts that property shares are trading at are sentiment related. “In the long term they [British Reits] are offering reasonable value,” he says. “But if you are looking at short-term returns you could still be in for a rough time.”

One of the main benefits of investing in Reits or other listed property companies is the liquidity they offer. Unlike direct property investment property shares can be traded within seconds. It is much easier to get in and out of your investment.

The ease of transactions also means investment in global property has become a lot easier. And according to Butler there has been an increase of overseas investment into British Reits.

“Reits is the global brand for property investment,” he says. “They make the UK market available for global investors. We’ve seen a significant increase in overseas investors [coming] into the UK Reits market. That’s been a major change. We have seen a lot of investment in the Far East over the past year. Globalisation is an important trend generally.”

Indeed, Arisse says the biggest overweight in the F&C Global Real Estate Securities fund is in Asia. He also points out that a more diverse shareholder base in property companies will lead to a more stable share price.

“UK Reits have seen a dramatic change in shareholder base,” Arisse says. “There are more overseas investors, especially Japanese and US investors. The more diverse the shareholder base the more stable the share price will be.”

Shipway of Thinc Group, however, is not convinced of the value of a global property shares market. He says other property markets do not have the same track record as Britain does. “Is it as resilient a property asset class as the UK?” he asks. “Europe does not have upward only reviews. I’d be much more nervous on a global basis. I would question how much embedded value is in global property or is it the hot thing of the moment?”