Research released this week by lettings platform Bunk showed that, at £51.9bn a year, the annual value of the UK private rental market outstrips the GDP of Myanmar, Luxembourg, Uruguay and Croatia. Despite this – and exceeding the market capitalisation of FTSE 100 blue chips such as Lloyds Banking (LLOY), Barclays (BARC) and Vodafone (VOD) – residential property isn’t the asset class it was.
Buy-to-let has been stymied by removal of income tax advantages and the surcharge on stamp duty for second properties, but expensive house prices also elevate the risk of an illiquid and possibly highly geared investment. Niche areas do, however, still provide opportunities for those hunting income and capital returns. Real estate investment trusts (Reits) focusing on social housing, homes for the elderly or student accommodation benefit from the liquidity of being listed vehicles, and can help investors purchase shares in a property portfolio at below its net asset value (NAV).
Intuitively, collective investment schemes are the best way for retail investors to get real estate exposure. This is a complex asset class and there is value to investment across several projects to spread the risk of failures. Yet, thanks to progress in blockchain technology, it is now easier to buy into individual developments, too.
Owning shares is fractional ownership, but what’s new is the ability to purchase digital security tokens. Blockchains are permanent and unalterable digital ledgers that can verify rights (including to income) of owning just a slither of an underlying asset. These rights can be conferred by holding digital tokens, the value of which is backed by the asset and is completely transparent, as each block on the ledger is made up of data containing verified transactions. As well as real estate, the technology has the potential to make investing in unlisted assets such as private equity and agriculture more accessible.
For retail investors, the attraction will be the chance to get involved in deals that were the past preserve of tycoons and institutional funds. Despite tokenisation having tremendous potential for granularity, initial token offerings (ITO) can stipulate a minimum buy-in, although this may be around £500, so not exclusive.
Due to the nature of real estate, individuals who are prepared to accept idiosyncratic project risks should be circumspect in the amount of capital they allocate to such investments. Tokens make it easier to risk smaller amounts in big real estate projects but proper research and risk/reward evaluation of projects is a lengthy process. This is underlined by the approach analysts take in review of investment companies’ whole portfolios. Studying coverage of specialist Reits is a revealing exercise, not only for judging the attractiveness of the funds but for understanding the factors behind potential success or failure of any specialist residential investment.
Valuing what you’re paying for
One of the first things investors look at with closed-end investment companies is whether the share price is at a premium or discount to the NAV per share of the fund. With Reits, this is more complicated than funds focusing on listed equity or bonds. Whereas the valuation of holdings in such highly tradable securities can be updated overnight, the NAV of property funds can’t be evaluated so frequently and it is far more difficult to assign fair value.
Best practice guidelines provided by the European Public Real Estate Association (EPRA) include accurate estimation of NAV, which it believes is not adequately expressed under IFRS reporting standards. The NAV measure preferred by EPRA is designed to exclude assets and liabilities “that are not expected to crystallise in normal circumstances such as the fair value of financial derivative and deferred taxes on property valuation” Furthermore, trading properties are “adjusted to their fair value under EPRA’s NAV measure”.
By this interpretation, the NAV per share of several specialist residential Reits is trading at a discount to the price of shares. Fairer accounting treatment is not the only consideration, however. There could be other investment issues for a Reit that affects the value of its income-bearing assets.
The Reit stuff?
|Focus||Share price (p)||Market cap (£m)||NAV per share (p)||P/NAV||Premium (discount) to NAV||T12 dividend yield|
|Unite Group (UTG)||Student housing||1043||3,028||36.6||28.50||2.8%|
|GCP Student Living (DIGS)||Student housing||164.6||681||165.52||0.99||-0.6%||3.8%|
|Empiric Student Property (ESP)||Student housing||90.5||546||108.5||0.83||-16.6%||5.5%|
|Civitas Social Housing (CSH)||Social housing||84.4||525||107.08||0.79||-21.2%||6.0%|
|Triple Point Social Housing (SOHO)||Social housing||87||305||103.65||0.84||-16.1%||5.8%|
|Residential Secure Income (RESI)*||Residential care||93||159||107.9||0.86||-13.8%||5.4%|
Sources: Company reports, S&P Capital IQ *Report only contained IFRS NAV
Take social housing Reits, for example. The ability of the Reit to harvest income depends on the financial health of the housing associations that it leases property to. If the level of rents is unsustainable, then the most likely outcome is a negotiation for less, as vulnerable tenants will not be evicted – the cost and political risk of such an action makes it virtually impossible. In such an instance, the value of the assets will be written down with the imminent knock-on effect a fall in the Reit’s share price.
Reviewing the robustness of every housing association a social housing Reit leases property to is an arduous task to be left to real experts. Peel Hunt’s report suggests that the viability of some of Civitas (CSH) and Triple Point’s (SOHO) top tenant housing associations is tenuous, so the price to NAV discounts these shares trade on are more a sign of justifiable caution – especially with regulatory focus on the supported living residential stock.
Student residential property is a different proposition but the sector remains tough to call, as demonstrated by the example of Empiric Student Property (ESP). In its July update, ESP confirmed it was trading in line with muted expectations set at its full-year results at the end of March. This included expectations of dividend cover of 85 per cent. Fast forward to 20 August and the half-year results suggest dividend cover of 94 per cent – quite an improvement – and the 2.7 per cent rise in EPRA NAV per share is good news too.
The performance of GCP Student Living (DIGS), which reported a 2.5 per cent increase in EPRA NAV per share to 165.52p between March and June, is also encouraging. Its portfolio is focused on London and the South East, and tenants are mainly overseas students, with 63 per cent from outside the EU.
Regional variation in asset concentration, different profiles of student groups and degrees of dividend cover, debt/leverage and forecast net operating income growth makes evaluating Reits difficult. Assessing individual developments that could be bought into via tokenisation requires the same rigour and there isn’t the analyst research available to support investors in the task.
Real estate is complicated, but tokenisation is a trend to follow
So while tokens may make it easier to invest in real estate, the opportunity requires diligence and a lot of research on every project – even more than buying a Reit. The technology itself, however, is worth keeping up with as it does open the door to high yield and previously illiquid assets.
In practical terms, investors will be keen to learn their rights and benefits as token owners, including how they receive income. Smartlands is one new platform using blockchain to help investors obtain fractional ownership of alternative and traditional assets and it was used to raise finance via a security token offering (STO) for a student development in Nottingham.
Regarding distributions, CEO Arnoldas Nauseda says: “[The] Custodian obtains dividends for equity held by [the] nominee (and represented by security tokens) from the ShareCo (Special purpose vehicle) holding the property. Dividends are then distributed proportionally to the amount of security tokens held by an investor on the record day.”
Many people will still confuse blockchain with cryptocurrencies such as Bitcoin and Ethereum but blockchain is just the means to verify ownership of the currencies and transactions. There is no need to acquire tokens in cryptocurrencies (although this is certainly available) and Mr Nauseda explains: “Investors that acquired security tokens during STO with fiat currencies (ie, issued by traditional central banks) will receive dividends in the same currency.”
Voting rights might be an area of concern for potential token investors but fintech entrepreneurs are adamant there is no need to worry. Securitize is a compliance platform and protocol for digital securities and its CEO, Carlos Domingo, says that voting rights can absolutely be coded into the token, depending on the class of underlying security and voter rights defined by the issuer. Mr Domingo argues: “Digital securities technology allows for precise, secure and instantaneous voting on a level that cannot be matched with legacy systems.”
Visibility of ownership is one of the equivocal aspects of blockchain that has perhaps clouded perceptions. On the one hand, transparency of ownership is hailed as a major benefit but the algorithms used to verify peer-to-peer transactions within data blocks can be bespoke and maintain the anonymity of participants who own the accounts. In the early days of cryptocurrencies, it was widely rumoured this had been seized upon by criminals for money laundering purposes.
Nefarious activities are a worry but this risk is hardly new for highly liquid asset classes and arguably the proprietary algorithms and compliance mechanics that token platforms use is better defence than the analogue surveys employed by traditional asset managers. In any case, while the identity of individuals/companies who control accounts can be hidden, the immutability and transparency of the blockchain makes it impossible to manipulate ownership of the tokens, so the most important aspect of investor security is maintained.
As it evolves, the token technology will be a secure way for investors to build their own bespoke portfolios. Although one big concern would be that protections offered for traditional methods of investing do not yet extend to token investments. For example, Smartlands told us that although funds that investors deposit on their website are eligible under the Financial Services Compensation Scheme (FSCS) – protecting deposits up to the value of £50,000 – “once the investment has been made (security tokens purchased) – it’s no longer covered by the FSCS”.
This may not concern speculators with a high appetite and tolerance for risk, and the technology lends itself to such individuals who also have a good deal of experience. La Estancia Holdings offers fractional ownership of real estate assets in the Caribbean. Head of Blockchain Strategy Laurent Chemla describes the risks and opportunity of tokenisation: “The same risks that are inherent to direct real estate investment could be found in tokenised real estate.” The benefits, however, are that as more assets become tokenised, investors will have greater flexibility to “choose fractions of properties they want to acquire; allowing them to design their own personalised, risk-diversified portfolio: a Reit 3.0.”
That’s an exciting prospect given the disparities between assets of the listed Reits investors can buy now. The flipside, however, is that although the technology will create new opportunities, investors are going to really need to do their homework on developments.