Land Securities and British Land - the two biggest property companies on the London stock exchange - should merge. This is not a new idea. But with returns from even the shiniest offices and jazziest shopping centres now shrinking as property values slide, it is overdue another airing.
I am sometimes asked which company I prefer. One can draw distinctions: British Land has a higher yield, more shops and an ex-banker in the top job; Land Securities is less geared, more development-focused and run by a chartered surveyor. But it’s a bit like debating the relative merits of Oxford versus Cambridge. To anyone on the outside, they are virtually identical.
Both run a mixture of central London offices and big shopping centres. Both have substantial development pipelines. Both are building skyscrapers within a stone's throw of each other in the City's insurance district. Both trade on the public market at substantial discounts to their book value - 18 per cent for British Land and 17 per cent for Land Securities.
These similarities mean a merger would create lots of synergies. That's all the more important because these companies may increasingly be valued for their capacity to generate a generous income. Indeed, one reason their shares trade on big discounts may be by way of compensation for mediocre portfolio yields; if the shares are cheaper than the portfolio, the dividend yields become acceptable - 5.4 per cent for British Land, 4.2 per cent for Land Securities. After the latest boom and bust cycle, investors have good cause to be sceptical of growth based merely on valuations movements.
British Land published its annual report on Friday, showing chief executive Chris Grigg was paid £2.18m last year, including pension contributions. That contributed to £76m of administrative costs – 13.3 per cent of gross rental income. That's not high by the standards of Land Securities, where the equivalent figure was 13.8 per cent (though the chief executive is paid much less, interestingly). But comparing British Land with Land Securities becomes a circular exercise: the cost-base of both companies needs to fall. As one stock broker put it to me: "These management teams don't represent good value by any measure, except a comparison with each other - which is what they do".
A merger would be an effective way to force through cuts - though it may not be strictly necessary, judging by the two smaller FTSE 100 real-estate investment trusts (Reits). Capital Shopping Centres spent just 8.8 of gross rental income on overheads last year, even including major acquisition costs it classified as exceptional. Hammerson also has a high cost base, at 13.6 per cent of gross rental income last year – but at least it has an explicit strategy to reduce it under new chief executive David Atkins.
Moreover, larger companies can borrow more cheaply than smaller companies. British Land and Land Securities already have good access to finance, but they would be able to drive their cost of debt even lower by joining forces. Since debt-interest payments constitute the biggest single expense of these companies, shaving a few basis points off the cost of debt could improve earnings and dividends substantially.
Of course, there are obvious obstacles to a merger. The companies have different capital structures; combining them would be a legal headache. Management teams would doubtless be opposed. The whole process might end up costing a year's worth of returns or more. Shareholders are usually right to be wary of grand visions.
Indeed, the sector seems to be fonder of de-mergers than mergers. Liberty de-merged into Capital Shopping Centre and Capital & Counties in 2010; Land Securities would have de-merged in 2008 but for the difficulty of divvying up its pooled debt between the divisions. Hammerson wants to sell off its London office portfolio and focus purely on shopping centres. Investors like specialists rather than generalists, and there are no clear economies of scale in the very local business of property management itself.
Yet there is a clear answer to these objections: look across the Channel. Unibail-Rodamco, the €13bn Franco-Dutch Reit created by a "merger of equals" in 2007, has been a startling success. Its overheads were just 6.1 per cent of gross rental income last year. Chief executive G Poitrinal was paid €2.08bn - about a fifth less than Mr Grigg at current exchange rates - even though he manages a company well over twice the size that has a much better track record. With a triple-A credit rating, Unibail-Rodamco can also borrow directly from the bond markets at cheaper rates than the French government. Its cost of debt was 3.6 per cent last year, compared to 4.9 per cent for Land Securities and 4.6 per cent for British Land.
British Land wants to "build the best Reit in Europe". Every specialist fund manager and stock broker I've ever spoken to agrees that crown currently goes to Unibail-Rodamco. Without doing something radical - such as merging with Land Securities - it's hard to see how British Land will win it.