The real-estate investment trust (Reit) sector may not be in much of a mood to celebrate its first birthday as the new year dawns. When the sector was born at the start of 2007, few predicted how quickly or how far property shares were set to fall - us included. The problems started with the profit-taking that followed the introduction of Reits in January. This stoked concern about the impact of interest rate rises on heady property valuations, which then turned to panic as the credit crunch bit. But can it get any worse in 2008?
Heading into the new year, sentiment is abjectly against commercial property. However, a lot of the potential pain has already been taken by Reits, which have anticipated falling commercial property prices by moving out to wide discounts to net asset value (NAV). For example, shares in Land Securities, the UK’s largest property company, currently trade at 37 per cent less than its September NAV.
But while property price falls are widely expected, there is still a lot of uncertainty about where prices will end up because the commercial property market has stalled in response to the vile conditions. That means there is very little transaction evidence on which Reits can base the valuations estimates for their assets. Still, despite this vacuum, valuers are advising property companies to amend portfolio values downwards, and the widely followed IPD All Property index has recently recorded the biggest monthly fall since the early 1990s. Indeed, the December valuations that the big Reits will release in the new year are expected to be gnarly.
Yet there are still some reasons to be cheerful. The market is yet to see much forced selling and, while buyers are remaining well on the sidelines, there is anecdotal evidence that there’s still a fair bit of money destined for the UK, from sovereign wealth funds to big institutions.
But while falling values are likely to steal most of the headlines as we move into 2008 and the market attempts to find its feet, the really big question for investors should be whether occupancy levels and rents can hold up. At the moment, the market is in a strong position from this perspective, but if economic distress spreads from the tattered balance sheets of big banks to the wider economy, it could really hurt tenant demand which ultimately underpins the sector. So, while discounts look temptingly wide and dividends are attractive, there is still room for things to get worse from here.
