Reits’ values slump but discounts persist

Real estate investment trusts’ (Reits) net asset values plunged in the second half of 2022 as valuers factored in higher interest rates – but their shares continue to trade on sizeable discounts to those values, suggesting opportunities for the brave. According to Investors’ Chronicle analysis, the Reits that have posted valuation updates so far this year recorded an average drop of 13.9 per cent for the six months to the end of 2022. The bulk of this decline occurred in the final quarter, when values slid by 11 per cent.

Their collective slump is also reflected in the wider market. MSCI’s UK index, which records valuation changes for directly held property investments, posted a 12.8 per cent drop for the final quarter, the worst quarterly performance since 2008. But Reits continue to trade at an average discount to net asset value (NAV) of 16.4 per cent, a slight improvement from the end of last year but still below historical levels.

Even though the downward swing in NAVs is an industry-wide trend, there were big differences between individual Reits. The worst performers were UK Commercial Property Reit (UKCM) and Tritax Big Box (BBOX). What the pair have in common is overexposure to warehouse assets – a sub-sector that has suffered disproportionately in recent months due to its prior strong performance. Greater liquidity in the sector’s underlying assets – for which demand remains relatively healthy – means valuers can more easily look to recent transaction activity when pricing NAVs, according to analysts at Numis. That suggests price discovery in this sector may be quicker to materialise than elsewhere. 

By contrast, west end retail and leisure landlords Shaftesbury (SHB) and Capital & Counties (CAPC), which are midway through a multi-billion pound merger, have experienced much smaller valuation declines. As online shopping pumped up warehouse values, it in turn depressed physical store values as retailers across the country fell into administration. The relatively minor valuation drops from retail landlords in recent weeks are evidence that the wider retail rout could finally be bottoming out. The bullishness of retailers expanding their physical footprint in recent months after nearly a decade of shrinking it supports this prospect.

The best-performing Reit was residential landlord PRS Reit (PRSR), which managed to post a small bump in value over the final half of the year. The company benefits from being the only UK Reit to focus solely on residential assets. PRS put its performance down to “strong estimated rental value growth of 5 per cent since 30 June 2022, underpinned by high demand for the company’s homes”. 

Another explanation is that PRS Reit is growing through acquisitions rather than higher valuations. Over the same period that its NAV increased by 0.6 per cent, the size of its portfolio in terms of the number of homes increased by 2.6 per cent. On a like-for-like basis, this would imply that the Reit suffered a fall in value.

On a share price relative to NAV basis, Assura (AGR) was the only Reit trading at a premium according to our analysis. Last November, in the wake of the market tumult caused by former prime minister Liz Truss’s mini-Budget, Assura was trading at a small discount, which is a historical rarity for the business.

The fact that Assura has returned to its premium status as the market has worsened goes to show the desire from investors to gain exposure to an asset class that should be resistant to cyclical market trends: hospitals are needed whatever the economic situation. Exposure to the non-cyclical world of healthcare may also explain the relatively small discount of care home landlord Impact Healthcare Reit (IHR).

The worst performers on a NAV basis were those who also suffered some of the largest valuation falls. Balanced Commercial Property Trust (BCPT) and UK Commercial Property Reit were two of these. The latter has already lost 29.4 per cent of its value, and the discount has priced in a further 27.3 per cent drop. This might turn out to be overly pessimistic, particularly if rental growth remains healthy and helps offset a portion of the capital falls. Custodian Reit, another portfolio focused on industrial assets, saw a much smaller NAV decline on the quarter – which analysts at Winterflood put down to its focus on “higher-yielding, smaller lot sizes, which were less susceptible to the market re-pricing”.

On balance, the Reits’ performance is mixed at best. Last November, we said that the 31 December valuations might offer some comfort after the mini-Budget fallout was calmed by Sunak premiership. Good news for the property market still looks some way off, but valuations have discounted a lot of damage already.