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FTSE 350: Rental growth set to buoy Reits

Supply constraints in London and rising employment in the crucial professional services sectors should boost office rents and underpin development profits this year.
January 29, 2015

UK real estate investment trusts own a broad range of property, from offices to shops, logistics warehouses to self-storage. Each sector has its own story to tell, but the broad theme running through last year's performance was the ongoing recovery in rents after the long slump that finally petered out in early 2013.

As in previous years, there were two markets: central London and elsewhere. Demand for office space in central London remained strong. With employment in the professional services sectors continuing to rise, it looks unlikely to dissipate in the coming year. Combined with supply constraints, this helped underpin an increase in rents. Meanwhile, rental growth outside London remains patchy: it all depends on the local balance of supply and demand.

Overall, however, commercial property rents posted their 16th consecutive monthly increase in November. That pushed the annual growth rate to 3 per cent - its best since March 2008. Yet rents are still 8 per cent below their pre-crisis high, and in real terms are down by a quarter.

Notable among the successes in London is Workspace (WRK). Increased interest in previously unfashionable areas of London helped boost book value by 20 per cent in the half-year to September, following a 43 per cent jump in the previous year. Retail landlords such as Shaftesbury (SHB) are also operating in a sweet spot, developing London's tourist heartland. Infrastructure improvements are likely to secure further increases in rents and hence capital values. The combination of Crossrail and an upgraded Thameslink service is set to transform journeys through central London.

Shops outside London present a more mixed picture. This reflects a change in consumer habits, with extra-large supermarket sites now looking vulnerable to a taste for convenience, both in the form of smaller, more local stores and online orders. In response, Land Securities (LAND) has been shuffling its portfolio of retail sites and has placed more focus on so-called leisure experiences - hence its purchase of a stake in Bluewater. Meanwhile, LondonMetric (LMP) has continued to focus on distribution centres, which should benefit from the internet revolution. This month it bought a nine-acre site in south London used by Tesco for its Tesco.com business.

Reits are also expected to deliver another strong capital performance this year as development projects reach completion. That's particularly the case for the London office developers Great Portland (GPOR) and Derwent London (DLN). Some companies are beginning to look at scaling back on the riskier development business in favour of generating a solid investment income stream. But the end of the development cycle, like its close cousin rising interest rates, remains a call perpetually deferred.

Company nameShare price (p)Market value (£m)PE ratioDividend yield (%)1-year performance (%)Last IC View
LondonMetric Property1589906.54.612.1Buy, 151p 26 Nov 2014
Redefine International REIT5471628.04.71.4Buy, 51p 29 Oct 2014
Derwent London3,1843,2735.41.022.3Buy, 2,983p 25 Nov 2014
Great Portland Estates7602,61464.41.320.9Buy, 686p 13 Nov 2014
Hansteen Holdings1107506.64.2-1.5Buy, 101p 28 Aug 2014
Land Securities Group1,2639,98429.92.520.9Buy, 1,145p 12 Nov 2014
Segro4073,0217.33.219.4Buy, 360p 30 Jul 2014
Workspace Group7921,27550.41.538.9Buy, 678p 12 Nov 2014
British Land8198,34127.83.421.7Buy, 744p 18 Nov 2014
Hammerson6685,23528.33.127.1Buy, 613p 12 Nov 2014
Intu Properties3584,70826.94.223.8Hold, 328p 4 Aug 2014
Shaftesbury7982,21865.41.726.2Buy, 808p 27 Nov 2014
Big Yellow Group6451,00815.02.427.8Hold, 563p 19 Nov 2014

Favourites

Regenerating London's tourist heartland is what Shaftesbury does best, and a significant improvement in transport links can only help boost tourist numbers. Capital values in the group's property portfolio rose by over a quarter last year, while rental income moved smartly higher too. With adjusted book value forecast to grow by 13 per cent this year, the shares' small premium to book looks justified.

Outsiders

Intu Properties (INTU) is expected to deliver another subpar performance this year. Analysts at Liberum have pencilled in just 1.8 per cent growth in like-for-like rental income in the three years to 2016. Void rates also remain stubbornly high at 5 per cent, compared with 2 per cent for its peers.