Despite widespread pessimism about the real estate sector during the early stages of the pandemic, there has been nothing but good news over the past year. The average house price hit £274,000, up almost 10% year on year, according to the UK House Price Index compiled by the Office for National Statistics, in an ‘unprecedented lack of supply’ . The number of new housing units completed remains constantly above 200,000 after ten years of declining production following the financial crisis.
The foreclosure has closed restaurants, cafes and pubs and moved shopping online, leading to many empty properties on the high street. But the premises were occupied by new tenants; only the old department stores are struggling to find new vocations. The focus on streamlining supply chains means the boom in logistics and warehouse real estate continues.
Workers have returned to the office, with homework limited to one or two days a week. Office vacancy rates in central London are near the long-term average and construction is almost in full swing. Real estate services firm Jones Lang LaSalle expects prime rents to grow for the year and deductibles to shrink. In March it brought in £6.6bn under offer and £2.2bn traded year-to-date, including the £718m purchase of the Scalpel building on Lime Street by a Singaporean buyer with a net yield of less than 4%.
Reasons to be careful
But investors remain wary of real estate investment trusts (Reits) and real estate stocks. Stock prices have moved little, if at all, over the past year. Those from Land Securities and British Land, which focus on offices and retail, trade at 20% net asset value (NAV) discounts. Even warehouse and logistics specialist Segro, the darling of the sector, is unchanged six months, so its premium to estimated NAV has fallen. TR Property (TRY), the £1.5bn trust investing in pan-European property stocks, is down 10% since the summer and trading at an unusually high discount of 9%.
Investors are probably right. Interest rates are rising and we are satisfied with the consequences. Right now they’re heading towards what would be universally described as reasonable levels, but the levels generally continue to rise until they cause pain on the principle that “if it doesn’t wrong, it doesn’t work.” The consequence is, if not recession, then a major economic slowdown, job losses and reduced demand for almost all goods.
In addition, long-term interest rates, the basis for fixed-rate borrowings, are rising. The ten-year US Treasury yield recently hit 2.5% and will likely go higher. Yields on UK gilts are 0.7% lower, but could catch up with – or exceed – US yields. In the United States, the standard 30-year borrowing rate for mortgages rose above 4.5%, signaling at least a slowdown in the market. House prices there and in the UK are unlikely to fall, but buyers can probably afford to be more price cautious and patient.
In the stock market, a considerable amount of bad news is expected, but investors are likely to wait until there is light at the end of the tunnel before pushing prices higher. Meanwhile, John Cahill of brokers Stifel points to very attractive funds with good inflation-protected returns based on rental properties with strong long-term covenants. These stocks trade at minimal, if any, discounts to net asset value, but future valuation gains are all but guaranteed.
Strong growth and inflation protection
Top of his list is Secure income (LSE: MR.), earning 3.8% on dividends expected in 2022. Nearly 90% of its revenue comes from an almost equal split between Merlin Entertainments (including Alton Towers and Manchester Arena), Ramsay Healthcare (11 private hospitals) and 123 hotels Travelodge. The average unexpired lease term is 30 years and most leases are directly linked to inflation.
Large Tritax box (LSE: BBOX), which “owns, manages and develops prime UK logistics property”, has been a star in recent years, so its 2022 return is below 3%. However, the market is still undersupplied, implying strong growth and inflation protection in a portfolio with an average remaining lease term of nearly 15 years.
The actions of Primary health properties (LSE: PHP) have been surprisingly lackluster over the past six months overall, despite a recent recovery. The result is a 4.3% yield on a dividend that has been increased for 26 consecutive years. The unexpired lease term of its properties is around 11 years, but these are medical practices and health centers whose rents are paid by the NHS. Lease renewals are very likely and rent increases, mostly linked to inflation, are guaranteed. Assura (LSE: AGR) is its equally attractive and equally valuable rival.
Lately, Supermarket income (LSE: SUPR) has been another success story with strong returns since its IPO nearly five years ago. As its name suggests, it owns and leases supermarkets to food retailers, whose business remains resilient. Shares yield nearly 5%, the average unexpired lease term is 15 years, and rent and dividend increases are built into the business model. Nervous investors will easily sleep with all these funds.