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British Land and Landsec: is there a path to rerating?

Shares in the commercial property giants are languishing at near-10-year lows as lockdown measures have cast a huge degree of uncertainty over the prospects for rental income
November 2, 2020
  • British Land and Landsec trading at 50 per cent discount to net asset value
  • The commercial landlords have suffered substantial shortfalls in rent collection this year
  • Both management teams aiming to dispose of retail assets and invest in office-led, mixed-use developments

British Land (BLND) and Landsec (LAND) are among a sliver of commercial real estate investment trusts (Reit) to have signalled that they will reinstate dividend payments. Yet those announcements have been met with a raised eyebrow by the market. Ahead of the release of interim figures later this month, shares in the Reits continue to languish at near-10-year lows as expectations abound that asset values will fall further as rents are rebased, threatening the scale and security of shareholder returns.

For the newly installed bosses of the commercial property giants – both of which were appointed during the past 12 months – the task at hand is driving growth from the more stable London office estate and reducing exposure to the retail sector. In keeping with the split of that portfolio, the shares' valuations – a 50 per cent discount to March NAV – sit above those attached to troubled retail property groups such as Hammerson (HMSO), but below pure-play office landlords such as Derwent (DLN) and Helical (HLCL). 

Like other retail landlords, British Land and Landsec have been punished for the sharp shortfalls in rent collection from retail tenants in the past three quarters. Most recently, the former received only 50 per cent of rent due from retailers for the final quarter, while Landsec reported an even worse collection rate of 33 per cent. With a second lockdown reinstated, investors may want to dim hopes of a substantial improvement in collection rates in the immediate term. 

A gradual reduction in the level of new leases agreed, versus previous passing rents, seems a certainty. It is envisaged that prime retail rents will fall by a net balance of 82 per cent over the next 12 months, according to respondents to the Royal Institution of Chartered Surveyors' third-quarter survey, as demand is expected to fall sharply over that period. 

The management teams are pinning their hopes on selling off more of their respective retail properties and ploughing the proceeds into growth-generating assets. For Landsec, that means disposing of around £4bn in assets over the next six years, predominantly “sub-scale” retail parks, hotel and leisure assets, and investing the proceeds in mixed-use developments, while continuing to focus on central London offices. British Land intends to hang on to its retail parks, but cut retail to between 25 and 30 per cent of the portfolio value, from 35 per cent at the end of March. 

Real progress on that front is likely to be slow. Yet investment volumes within the retail market are painfully low. “The key thing for anyone with retail properties is the need for some market evidence on valuations,” said Colm Lauder, analyst at Goodbody. More deals being agreed could give investors more confidence in British Land and Landsec, either by positively surprising or – more likely – simply allowing the market to get a better handle on the value that could be generated from their disposal programmes. 

But with retail accounting for 57 per cent of British Land’s annualised rental income at the end of March and 42 per cent for Landsec, the sale of more of these assets, combined with lower rents attached to those they retain, means the Reits are likely to have to sacrifice income in the short term, which may well mean dividends are a shadow of their former selves. “They’ll be sacrificing income in the short term to secure their balance sheet in the long term,” said Mr Lauder. 

It also places increased importance on generating rental growth from office assets, too. Yet while the rental value attached to those portfolios has risen in recent years, the rate of growth has hardly shot the lights out. For Landsec, like-for-like rental income from its offices was up by just under 3 per cent during each of the past three years. Meanwhile British Land reported 0.8 per cent growth in its London offices during the last financial year, down from 4.9 per cent and 2.4 per cent during 2019 and 2018, respectively.

In their corner, both groups have substantial headroom on their respective debt covenants. Yet analysts are forecasting a fall in earnings per share for both Landsec and British Land of around a quarter in 2021. Those expectations could well fall further as we gain a clearer picture of the impact of a second lockdown on the retail and leisure industries’ ability to make rent. With that in mind, and little chance of the retail investment springing back any time soon, the odds are stacked against the shares rerating any time soon.