- Segro raised equity at a discount to NAV
- Other Reits could follow suit
It was the moment many real estate investment trust (Reit) investors were waiting for. Last month, the UK's biggest Reit, Segro (SGRO), raised £907mn in an oversubscribed equity raise with plans to spend that cash developing its sizeable pipeline of warehouse projects.
The move intends to capitalise on tenant demand for warehouse assets as the real estate market recovers, but not all equity raises happen from a position of such strength. This week, Regional Reit's (RGL) share price sank by a third after it confirmed reports that it was considering an equity raise at "a material discount" to its share price to pay a maturing bond.
Amid so much equity-raising activity, it is worth considering which Reits might follow suit, and the alternative options available to those who can't or won't do so.
The Reit choice
Andrew Saunders, a real estate analyst at Shore Capital, notes that most Reits favour equity raises to generate funds for growth. "It's one of the reasons you seek to become a public company," he says.
"Equity is seen as less risky than debt in the long term. So, if shareholders are supportive and you can do it without diluting earnings and net asset value (NAV) to a material extent, then it's worth it."
The issue many Reits have had since the market began to slump in 2022 is that they cannot currently raise equity without doing it at a discount to NAV (see chart). Segro trades at around NAV but crystallised a discount when it raised equity at 820p: a 7.55 per cent discount to its 887p NAV, to be precise. Still, the success of the raise shows the market felt this was acceptable. By contrast, the market reacted badly to Regional Reit's potential raise at a wide discount. The fact the announcement came with red flags around bond payments would not have helped either. It begs the question of how much is too much when it comes to discounts to NAV in equity raises.
"That’s a question only shareholders can answer,” says Saunders, although in any case he argues that UK Reit investors are sometimes too focused on NAV discounts. He points to the US, where different accounting rules mean less investor focus on NAVs. Instead, US Reit valuations concentrate more on earnings and earnings growth.
This was precisely the pitch Segro made last month. While the move may dilute returns for existing shareholders in the short term, the Reit said it could generate a yield of up to 8 per cent from using the cash to develop its pipeline. "Segro has shown discount to NAV is not a deal-breaker for raising equity," says Saunders.
Sheds, beds, and meds
In terms of other potential raises, any Reit that invests in an asset class with high property yields has potential, according to Saunders. He suggests that other warehouse Reits, such as Tritax Big Box (BBOX), Urban Logistics (SHED) and Warehouse Reit (WHR), fit that bill.
Those in other sectors with strong demand, such as accommodation, healthcare and self-storage, might also qualify. Grainger (GRI), Empiric Student Property (ESP), Assura (AGR), Primary Health Properties (PHP) and Safestore (SAFE) match that description. Meanwhile, Unite, Big Yellow (BYG) and Lok'n Store (LOK) have already raised equity in the past couple of years – Big Yellow as recently as October.
That looks like a long list of potential raises, but there are reasons to be doubtful about such a rush of activity. PHP tells Investors' Chronicle it will not follow in Segro's footsteps because of its discount to NAV (currently 4 per cent) and because it could not fund development "accretive to earnings".
In other words, even if some investors might be willing to stomach equity raises at a discount for Reits in sectors with strong demand, the Reits might be less willing to take that risk. Moreover, high demand does not necessarily mean a high property yield or indicative of earnings-enhancing development opportunities. As PHP's main tenant is the NHS, negotiating rental increases high enough to justify raising equity for development is harder than for a private company. Assura is in a similar position.
"There will be more equity raises, for sure," says John Cahill, analyst at Stifel. "But this is not an opening back up of the equity market in a usual sense because the discounts are very large, and there's not a market to deploy the capital into in the first place."
What else?
If Reits can't raise equity, there are other choices. But using debt, to take one example, is clearly unattractive when interest rates are high, and many Reits have higher loan-to-value ratios than they would like because of how high interest rates have hurt their property values.
As such, some have resorted to selling assets, which has the benefit of raising cash for reinvestment into higher-yielding property as well as paying down debt. This 'recycling' strategy is popular among Reits where tenant demand and discounts to NAV mean equity raises are more of a challenge.
Hammerson (HMSO) has raised over half a billion thanks to its "non-core disposal programme" (ie offloading its unwanted stock), and Land Securities (LAND) and British Land (BLND) have recycled billions over the past few years. The downside of selling off large chunks of your portfolio is earnings per share fall as you collect less rent in the short term.
That leaves mergers, but these are not always straightforward. Shaftesbury Capital (SHC) looks like a success since its own big deal, but LondonMetric's (LMP) acquisition of LXi involves taking on some of the tenant risks in LXi's portfolio. Meanwhile, Custodian's (CREI) acquisition of Abrdn Logistics Income (ASLI) has been interrupted by Urban Logistics, and UKCM (UKCM) rejected Picton (PCTN) before opting for Tritax Big Box's (BBOX) offer – which attracted criticism due to how it would move the portfolio away from warehouses.
Like equity raises and all the other options, mergers come with myriad downsides. With the stakes high, investors should scrutinise whatever move a Reit opts for.
