UK commercial property is out of favour as an asset class. Professional valuers have been desperate to mark it down since the Brexit vote, while herd-following investors have shunned it. Listed real estate investment trusts (Reits) with large commercial portfolios are reducing their debt levels and reining in their development programmes.
But as an investor you need both to judge the underlying reality and the prevailing sentiment. It is no good being right about the economics if most other investors are enjoying their right to be wrong. It may take time before the reality overwhelms them.
UK commercial property may be such a case. At the very time UK listed Reits are cautious and their property valuers are fearful, overseas buyers are piling into London like there is no tomorrow. City skyscrapers have sold for sky-high amounts. In March a Chinese property developer paid £1.15bn for the Cheesegrater — a yield of just 3.45 per cent. This price was 26 per cent more than its recent September valuation.
Then the Walkie-Talkie was sold to a Hong Kong investor for £1.3bn — 13 per cent above its book value, at a time when shares in Landsec, the property company that sold it, was trading at a 29 per cent discount to NAV.
These prices surprised the worriers. Now the gloomy pundits are arguing that Chinese buyers will be impeded by new rules there seeking to damp down buying foreign properties, citing Dalian Wanda’s decision to drop its £470m purchase of a 10-acre site in Nine Elms. Effective Chinese controls would be bad news, but that deal was soon resurrected by two other Chinese buyers at the same price.
I did buy the FT fund some more UK quoted property through an exchange traded index fund shortly after the Brexit vote. I sold at a modest profit later in the year, having made my point that the panic on the news of the decision was unjustified. Since then, shares in UK Reits have gone sideways. But where will they go next?
Some are pessimistic because they think large financial companies will leave London for Wall Street, or European capitals. Yet Wells Fargo has announced a major investment in new City offices, and other financial firms have taken additional floor space or upgraded their offices. In any case, tech businesses in London now require more new space than the financial sector.
Warnings of job losses also occurred years ago when the UK declined to join the euro — but they did not happen. In the year since the Brexit vote, London’s jobs market has been buoyant.
Others fret about several large new office developments under way in the City. Adding these all up does not produce a worryingly large figure. Property company Derwent London forecasts 6.2m sq ft of extra space this year, falling away to just 3.6m in two years’ time. Much of this is pre-let. So far, rent levels have held firm and buildings have been let relatively easily. Deutsche Bank has signed a 25-year lease to occupy almost half a million sq ft of new space in Moorfields, taking most of the development as it consolidates its other offices.
After the Brexit vote, many valuers argued that buildings must have fallen by 10 to 15 per cent. Some property funds temporarily “gated” and stopped allowing unit holders to sell for fear of a stampede. Paradoxically, they also stopped those of us who were optimistic from buying in at the depressed valuations they were citing. For foreign investors, property is more attractive thanks to the further fall in the pound.
Many listed Reits have marked down their portfolio valuations, only to start marking them back up again. Meanwhile, the list of fully let completed properties sold for above their book value gets longer.
The present reality is you can buy into Reits at discounts of 20 per cent or more to their net asset values — and that NAV is an understatement of the likely present sales values of the underlying properties. It is a double discount.
Although I trimmed the FT fund’s property holdings for tactical reasons, I am now tempted to add more. Yes, the pessimists will argue that the exodus has been delayed and that downward pressure on rents will come later. You can never be sure of when sentiment and reality will coincide again. But in a world starved of income, shares offer better incomes than bonds, and properties often now offer better incomes than shares — so that gives me some comfort.
John Redwood is chief global strategist for Charles Stanley. The FT Fund is a dummy portfolio intended to demonstrate how investors can use a wide range of ETFs to gain exposure to global stock markets while keeping down the costs of investing. firstname.lastname@example.org
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