REIT Sector Overview
Are REITs an attractive proposition?
REITS or Real Estate Investment Trusts provide investors with the opportunity to take a position in commercial and residential property without having to directly own the underlying asset. The sector has seen significant turmoil over the past 12 to 18 months, with defaults and question marks over valuations. Investors have previously faced over a decade long search for yield with interest rates low for a prolonged period of time. The landscape has now all of a sudden changed, with investors being offered the prospect of a 5 to 6 percent yield on cash deposits.
Real Estate Investment Trusts previously offered high income yields that could fill in for what fixed income and cash wasn’t providing. The REIT landscape has been shaken by the post-COVID changes in real estate demand, with the rise of Hybrid working as well as interest rate hikes.
REITS rarely have the luxury of being sat on a net cash position and so the rise in interest rates will perhaps restrict the capability to grow significantly as the ability to acquire properties or other REITS through leverage is increasingly difficult, owed to amplified cost of borrowing money. Supermarket Income REIT funded its recent acquisitions by selling stores to Sainsbury’s, removing properties with low yields and using the money to buy ones with high property yields. Company debt in the current climate is an aspect to factor in, as refinancing will no doubt be on the agenda for management teams and a ‘higher for longer’ rate environment may leave some companies vulnerable. Conversely, debt is prominent within the sector and so REITS are usually well equipped to deal with rising rates by locking in tenants with repayments that are index linked. To demonstrate the above we have highlighted LXI’s recent trading update for six months to 30 September 2023.
The update saw their property portfolio valued at £3.19bn reflecting 5.70% net initial yield which demonstrates a decline on the last trading update on 31 March (£3.36bn / 5.35%). Many REITS have seen a decline in rent payments which of course can lead to angst and doubt among shareholders.
However, the group saw a 100% rent collection for the half year with the Portfolio 100% let, with 98% of rent benefitting from inflation-linked or fixed rental uplifts. The company continues to target a dividend of 6.6p per share for the 12-month period to 31 March 2024.
Loan to Value at period-end was circa 38%, within their target range of 30%-40%. 100% of drawn debt is fixed or capped, with a weighted average term to maturity of 5.2 years and a weighted average capped interest cost of 4.7% p.a. Therefore, the company isn’t overly exposed to any major refinancing and although the Loan to value is relatively high (in effect 38% of the value of the funds is owed to borrowings and debt) the fund is in reasonable financial shape, stating that priorities for the next six months include recycling capital through further asset sales and regearing shorter-let assets in the portfolio. The stock currently trades at a discount of approximately 25%.
LXI trade on a price to earnings ratio of 11.2, which compared with British Land on 11.3, Land Securities on 11.7 and Segro on 21, would suggest the REIT space presents attractive value with the FTSE trading on a PE of 14, further reflecting the negative sentiment toward the sector.
So this begs the question, is the REIT space set for a recovery amidst speculation that interest rates have peaked or all but peaked. Refinancing in the current climate would leave many companies vulnerable, not just Real Estate Investment Trusts and so how would the space fair amidst the current base rate remaining at a ‘high level’ for the foreseeable.