Matthew Norris, Director of Real Estate Securities, explores some of the compelling opportunities in the real estate sector.
In a world of increasing uncertainty, the VT Gravis UK Listed Property (PAIF) Fund invests in best-in-class owners of property, serving the critical needs of today and the demands of the future for the next generation. The Fund focuses on four socio-economic trends shaping the real estate sector such as our rapidly ageing population, the move to digitalisation, ‘generation rent’ and the trend towards urbanisation.
The average age of the UK’s population is rising, with the ONS projecting the over 65s will make up 26% of the UK’s total population by 2041 (c.18.9% in 2022), a proportional increase of nearly 10% from 2016. Over 85s are the fastest growing age cohort in the UK and are frequent users of primary healthcare services. Rather morbidly, but no less telling, funeral services revenues are set to grow by a compound 4.8% over the next five years. Ageing and it’s inevitable conclusion is a growth sector.
And so it is that providers of property catering to the healthcare needs of our elderly cohort, are enjoying increasing demand for their assets and few more so than Primary Health Properties and Assura. Both companies are REITs and both own portfolios of modern buildings benefiting from increased demand for higher quality local healthcare, and are set to continue to gain from a growing investment in the provision of these services.
Another name in the sector benefiting from this increasing demand is Impact Healthcare REIT, the owner of high-quality care homes in the UK, which declared a 2.0% annual increase in its fully covered Q3 dividend. The REIT is on track to meet its target annual dividend of 6.54 pence, representing an attractive 6.4% yield. This level of dividend and income growth remains sustainable, with the portfolio of long leases benefiting from 100% inflation-linkage.
Whilst the UK population continues to age, it is also embracing technology. The high-street heyday is over, online shopping with its convenience, price transparency and product breadth, is here to stay, but its efficiency is completely dependent upon a network of logistics warehouses, from big boxes to urban warehouses located near city centres ensuring our same and next day demands are met. Seeking modern logistics facilities, e-tailers are turning to REITs such as Warehouse REIT and Segro to lease their warehouse space.
Segro, a leading owner and developer of modern warehousing across the UK and continental Europe, recently reported strong results. Of particular interest, beyond the reported 7.1% like-for-like net rental growth, Segro has a significant development pipeline of largely pre-let properties, which will further bolster its already strong growth potential. This pipeline alone has the potential to generate £118m of new rent. Considering the current headline rent for the entire portfolio of standing assets is £590m per annum, the new developments have the potential to deliver meaningful growth for several years to come.
Looking to ‘generation rent’, renters are seeking a higher-quality accommodation, choosing properties owned and managed by professional landlords such as The PRS REIT. Unlike amateur buy-to-let landlords, REITs which offer a spread of domestic property types including family homes provide a high-quality, high-service experience and properties in desirable locations. The result of these positive forces is strong rental growth. The PRS REIT reported “rental growth on lettings to new tenants at circa 10%... significantly higher than the average rental growth of 5.1% across the portfolio of stabilised assets.” In today’s inflationary world, such growth rates are likely to expand the appeal of family homes as an investible property type.
Within the urbanisation mega trend, Derwent London, the design-led London-focused office REIT, recently reported that leasing in the first half of 2022 was strong, with new rents signed on average 9.3% above December 2021 estimated rental values. 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.” Derwent has also increased its interim dividend by 4.3% to 24.0 pence per share. Boosted by growing rental income, as the ‘flight to quality’ continues to push up rents, the REIT is on track to deliver its 15th consecutive year of dividend growth – an impressive track record. This ‘flight to quality strategy’ has meant Derwent are 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.
Despite positive results from the high-quality, specialist REITs in which the Fund invests, the REIT market has not been immune to recent market turmoil, with markets pricing in higher valuation yields (lower property values). The divergence between the continued strong property leasing fundamentals and the share price performance of REITs has created a significant valuation gap and generally speaking, UK REITs are trading at a significant discount to NAV.
The size of this valuation gap is a rare, but not unique, occurrence. During the past decade, there have been a few occasions when REITs have traded at a 20%, or greater, discount to NAV*. 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 NAV. However, when looking to take advantage of REITs trading at a discount to NAV, caution must be exercised rather than an indiscriminate focus on ‘bargain hunting’. REITs benefiting from the socio-economic trends mentioned above being well placed to outperform.
At present, it is hard to envisage a situation where REITs derate much further before the prospect of M&A becomes very real. Given the current discounts to NAVs and the devaluation in sterling, it would not be surprising to see take-over interest in some of the REITs that own the next generation of real estate assets.
In a world of uncertainty and volatility, the Fund remains focused on investing in the best-in-class owners of high-quality real estate delivering reliable and growing dividends. Despite the near-term uncertainty, long-term demand for best-in-class next generation real estate assets is likely to persist.
Capital at risk. Past performance is not indicative of future performance, the value of your investment may go down as well as up and you may not get back all that you invested.
* Proprietary Gravis Advisory Ltd Research, Bloomberg