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Respected real-estate analysts at Lehman Brothers, who called time on Real Estate Investment Trusts (Reits) in April before the worst of this year’s precipitous falls, have turned positive on the sector again.
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That may sound strange to some, especially investors in New Star’s flagship UK property unit trust who still have a 17.8 per cent unit price drop ringing in their ears. But, much of the pain that open-ended funds and the wider commercial property market is experiencing has already been borne by Reits, which have moved to large discounts to net asset value (NAV) in anticipation of price falls.
What’s more, Lehman Brothers reckons that when property transactions pick up again, prime real-estate assets, of the type that most Reits are focused on, will emerge devalued but stable. The broker thinks current sector discounts of 32 per cent to NAV are excessive. It points out that once Reit tax changes are taken into account, discounts are at similar levels to those experienced during the 1990s crash.
But even for those who agree with this view, the pain in the property market is not necessarily over yet. For one thing, Lehman's predictions are contingent on credit market congestion easing. The value of commercial property deals has dived during the second half of the year as buyers have struggled to find credit and waited for prices to adjust downwards, and exactly where they’ll adjust to is yet to be seen. Another big question is how tenant demand and rental growth will hold up as the economy weakens in 2008.
Holders of lower quality assets with high debt levels look particularly vulnerable in 2008. The difference in the valuations commanded by low and high quality property assets remains minimal but it looks like this needs to be corrected. Indeed, companies and funds that are invested in this part of the market could provide fodder for more horror story headlines next year. Fortunately, Reits don’t fit this bill.
We see value in some of our sector favourites (Land Securities and British Land), but with many potential ghouls still lurking in the shadows, sentiment could take some time to turn yet.
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