Real estate investment trusts in the U.K. must grow a lot bigger if they are to deliver sufficiently attractive returns to investors over other sectors and forms of property ownership, according to leading figures in the country's property sector.
Speaking at the European Public Real Estate Associations Insight 2021 webinar Jan. 5, the CEOs of U.K. REITs Landsec and Tritax Big Box REIT PLC, alongside the head of property investment at BMO Asset Management Ltd., called for greater scale and specialization in the sector.
REITs — publicly-listed companies that own, operate or finance income-producing properties and distribute the vast majority of their taxable income to shareholders — were introduced in the U.K. in 2007 with the aim of increasing investment in the real estate market. While the sector has grown since then, the shares of many U.K. REITs have traded at significant discounts to their net asset value in recent years due to lack of interest from equity investors.
"Ultimately, we need to grow REITS," said Marcus Phayre-Mudge, fund manager at BMO Asset Management. Phayre-Mudge manages £1.4 billion of assets as manager of TR Property Investment Trust, which had over £380 million invested in U.K. listed property companies as of Sept. 30, 2020.
"We need to encourage the small investor [and] the wealth manager to think about REITs and listed property companies as the way in which they should get their exposure to the real estate sector," he added. "Therefore, it's about reducing volatility, reducing costs and increasing total return."
The U.K. REIT sector consisted of 59 companies with a combined market capitalization of almost £55 billion as of the end of June 2020, according to a report by EPRA. While the number of REITs has increased from 40 in 2016, the total market capitalization of the sector has only slightly increased from around £48 billion in that time, EPRA data showed.
U.K. REIT share prices during that period have been hit by uncertainty surrounding the country's departure from the European Union, ongoing structural changes to the retail sector, and most recently the COVID-19 pandemic. Landsec and British Land Co. PLC, formerly the U.K.'s two largest REITs by some distance, have seen their share prices fall by around 50% in the last five years.
"The REIT sector in the U.K. needs to grow a lot bigger," said Colin Godfrey, CEO of logistics warehousing REIT Tritax Big Box, which has a property portfolio worth £4.18 billion as of the end of June 2020. "We need more bigger REITs in the U.K., much more akin to the U.S. process."
The US REIT market is the largest and oldest in the world. There were 191 US REITs as of the end of June 2020, with a combined market capitalization of more than $1 trillion, EPRA data showed.
Godfrey said that he expected to see greater specialization among REITs in the coming years as it was needed to deliver the kind of returns that would attract more investors. "Specializations are key to value delivery in your field," he said. "The real estate sector is just too broad. You can't be a master of all those areas."
Diversified REITS — those that own and manage property assets across different subsectors — make up the majority of U.K.-listed REITs, according to FTSE ICB sub-sector data on the London Stock Exchange website.
Specialized REITs have experienced mixed fortunes in recent years. Segro PLC, which is focused on the European industrial and logistics subsector, became the largest U.K.-listed REIT by market capitalization in 2018, surpassing diversified REITs Landsec and British Land in the process. Meanwhile, the share prices of retail-focused REITs Hammerson PLC and Intu Properties PLC Intu plunged in recent years, with Intu eventually delisting after falling into delisting in June.
Having an edge
Tritax Big Box, whose specialization in the structurally attractive logistics warehousing subsector is similar to that of SEGRO, has enjoyed strong growth since it floated in 2013. The company's share price has risen around 70% since then.
"We believe we are the most knowledgeable and experienced investment manager and developer in our field, in big box logistics in the U.K. market place, and having the knowledge in that field gives us the edge," said Godfrey. "Having that edge is absolutely crucial in the modern age."
Mark Allan, CEO of diversified REIT Landsec, said that having "huge scale and a very thin cost base" through specialism is "one of the ways REITs as a proxy for holding real estate can work."
Allan, who took over his role in May 2020, said that his company was shifting strategy away from holding assets in order to play to its strength of "creat[ing] value through real estate interventions" in the form of development or asset management. "That's ultimately a total return story," he said.
"Sitting on assets you can't add a lot of value to, with a big cost base and talented people within the business that are wired to add value to assets, is a disconnect," he said.
The company, which had a U.K. property portfolio valued at £11.8 billion as of the end of September 2020, is one of many U.K. and European REITs whose shares trade at significant discounts to their net asset value. "One of the things the discount is telling us is that there are other pools of capital out there that value our assets more highly than equity markets do — and we need to take advantage of that," said Allan, who highlighted the company's sale of assets since he took charge and plans to recycle that capital through development.
A more active approach with a greater appetite for risk should deliver the kind of returns that will attract investors back to the company, Allan added. "[The NAV discount] points to us needing to deliver a total return which justifies a valuation closer to NAV."