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Where can investors find recovery potential in property shares?

Commercial eviction moratoriums and construction site closures hammered earnings for landlords and housebuilders last year, but the worst could be behind some
Where can investors find recovery potential in property shares?
  • Student landlords have the highest earnings growth expectations attached to them for the next two years
  • However, those with larger rates of forecast earnings growth also have higher risk attached to their income streams

The UK may have been thrown back into full lockdown, but analysts have stood by expectations of a recovery in earnings this year for many of the housebuilders, real estate investment trusts (Reits) and property services groups listed in London. 

An improvement on the dismal performance from most property groups during the last 12 months is hardly a great feat. At the extreme end, statutory earnings for retail and hospitality landlords such as Hammerson (HMSO) and Shaftesbury (SHB) were wiped out by heavy devaluations in their retail property portfolios. 

Yet even excluding those valuation movements, earnings for commercial landlords across a variety of sectors have suffered as a moratorium on evicting tenants for non-payment of rent and a rise in occupiers going bust caused rent collection rates to dip. Meanwhile, for the UK’s major housebuilder, the enforced closure of construction sites under the first lockdown hammered completion levels, which even a stamp duty break-induced frenzy in home purchasing could not compensate for. 

However, an analysis of consensus earnings per share forecasts collated by data provider FactSet shows that the compound rate of growth anticipated over the next 24 months is high for some companies. In an attempt to account for some of the natural skew towards companies that suffered the worst declines in earnings during the last 12 months, we excluded the housebuilders, Reits and real estate services groups with the weakest earnings growth rates – or rather largest rates of decline – during that period. 

Forecast highest recovery (%)
CompanyTotal return (YTD) (%)Forecast two-year EPS CAGR (%)Annual EPS growth (last 12 months) (%)
Empiric Student Property-0.437.4-43.4
Unite-3.336.7-37.6
St Modwen Properties-4.536.4-33.5
Savills3.530.1-36.3
Springfield Properties-1.728.3-25.9
Residential Secure Income-0.227.12.4
GCP Student Living-1.022.8-30.5
Shaftesbury-5.820.9-47.6
Urban Logistics REIT-0.519.5-8.4
Bellway-1.118.1-44.7
Great Portland Estates-1.317.0-12.9
Barratt Developments-2.316.8-35.9
Warehouse REIT-1.015.6-13.1
Workspace-1.613.6-41.0
Derwent London0.111.7-5.8
Source: FactSet

 

High expectations for student landlords 

On that basis, student accommodation providers Empiric Student Property (ESP) and Unite (UTG) take the number one and two spots, with analysts forecasting earnings to grow at a compound annual rate of 37.4 per cent and 36.7 per cent, respectively, over the next 24 months. By FY2022, earnings for ESP and Unite are forecast to be above 2019 levels by 6 per cent and 14 per cent, respectively. GCP Student Living (DIGS) is also forecast to increase adjusted earnings by almost 23 per over the next 24 months.

All three student landlords suffered a loss in income after forgoing rent for students that returned home in the wake of the pandemic outbreak last year and bookings are down for the 2020/21 academic year. Unite reported the highest lettings rate for the academic year at 88 per cent in November, with 80 per cent of students having checked-in, although that was against a summer target of 98 per cent.  

A relatively fixed cost base means that any decline in occupancy has a material impact on earnings, says Numis director of real estate research Robert Duncan. “As soon as you get any degree of normalisation then you will see a material recovery in earnings,” he says. 

Whether the earnings recovery comes to fruition over the next year will largely depend on the vaccine being rolled-out according to government targets over the next few months and the spread of the virus not worsening even further. Failure to achieve that could weaken confidence in students to sign new leases for the upcoming academic year and result in further travel restrictions that inhibit international students moving into UK university accommodation. 

Unite has an advantage over Empiric in that rent is set at a more affordable level that means it appeals to a greater proportion of the student market, argues Mr Duncan. “What that means is it’s not a massive gap if you suddenly see a reduction in international students,” he says. “You’re not going to have to massively discount your rates to attract more domestic students.”

Unlike Empiric and GCP, Unite also lets more than half of the beds in its portfolio via nomination agreements. Under nomination agreements, where a university nominates a minimum number of students into the accommodation each year and for an agreed period, in return for a level of control on rents. That gives a greater level of visibility over future revenue, which can also be reflected in the valuation of the portfolio.

 

Housing market hopes

Housebuilders Bellway (BWY) and Springfield Properties (SPR) and estate agency Savills (SVS) are also expected to benefit from a bounce back in the UK housing market. Scottish housebuilder Springfield is forecast to grow earnings at a compound annual rate of 28.3 per cent, while larger peers Bellway and Barratt Developments (BDEV) are expected to grow earnings by 18.1 per cent and 16.9 per cent, respectively, during the same period. 

That compares with 6.4 per cent for the largest UK-listed housebuilder, Persimmon (PSN). However, the higher earnings growth is largely due to these groups’ earnings recovering from a lower base than sector titan Persimmon. 

“Persimmon wasn't as impacted by 2020 as some of the other players in the space because of the strength of the balance sheet they were able to continue to invest in building through the early summer,” says Peel Hunt analyst Sam Cullen. Indeed, the level of gearing on the balance sheet is at the core of how well the sector’s players will be able to not only withstand any further disruption to completion levels, but also maintain and eventually grow dividend payments to shareholders. 

Many of the companies with the highest earnings recovery potential also have higher risk attached to their income streams. Yet where companies are operating in sectors with limited supply, such as student property or prime office space, and solid enough balance sheets, taking a contrarian approach could prove to be worth it.