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Equity markets continue UK REIT discounts over property fears

Equity markets continue to discount U.K. REITs over fears of a looming property downturn, despite signs that property values have held up.

Fifteen of the 20 largest listed U.K. real estate companies still reported net asset value discounts following the June 23 referendum to leave the European Union, an S&P Global Market Intelligence analysis showed. Analysts said stock markets had deepened discounts on listed U.K. companies to price in future property value declines, with years of uncertainty ahead due to the Brexit negotiations.

"We look at where transactions are going through in the actual underlying real estate market, and they are going through at book values, or in some cases even above," said David Prescott, equity analyst at Barclays, in an interview. "So we believe that NAVs are not overstated, and they’re not falling."

Numis Securities equity analyst Robert Duncan said in an interview that there are further concerns that historically low yields and rents at historic peaks across most U.K. sectors indicated the cycle had peaked even before the June referendum and is now in its "twilight stage." The property market now faces a period of "directionless volatility," he added.

"I don’t think there’s going to be a clear pattern of upwards or downwards — it will be directionless because [the companies] can’t tell us anything," he said.

Listed real estate companies will have limited options to bolster market confidence. Strong asset sales that prove book values or higher are one way to chip away at downturn fears among investors.

The London office market is still considered the epicenter of Brexit uncertainty, even after notable sales, such as Great Portland Estates Plc's £276.5 million sale of a London asset in November. The sale was expected to boost market confidence by returning a whole-life capital return of 75% and showing an appetite for London commercial real estate, but sentiment didn’t budge.

Duncan said listed real estate companies should avoid focusing on share prices. "They need to continue to concentrate on letting space, proving [estimated recovery values] at the market rate and actually crystallizing profits where they’ve been made," he said.

Prescott said he believed there is long-term value in U.K. REIT stocks, but it is tough to anticipate a share price re-rating without an obvious catalyst in sight. "Share buybacks is a discussion that some of the companies need to think about," he said.

However, Duncan disagreed and said companies would be wise to avoid share repurchases in their attempts to normalize NAV discounts, as that would increase leverage and offset any NAV gains because of the increased risk.

The ongoing NAV discounts have also stirred industry talk of possible M&A scenarios. However, Prescott said that was unlikely, as any takeovers would attract a significant share price premium and return prices to NAV levels or even higher.

As of Dec. 19, S&P Global Market Intelligence figures showed NAV discounts across major UK companies, such as Land Securities Group Plc at 20.5%; British Land Co. Plc at 21.4%; Hammerson Plc at 16.3%; Intu Properties Plc at 19.6%; and Great Portland at 11.9%.