A tough 2022 left London-listed real estate investment trusts (Reits) trading at wide discounts to asset value, but while their shares face uncertainty from the economic outlook this year, investment bank Numis Securities believes much of this is priced in as it highlights four property investment companies it considers offer good secure yields for income investors. 

Background

The property sector endured a widespread repricing last year as central banks hiked interest rates in the battle against inflation, government bond yields rose sharply, and weakening economies cast a question over rental growth. As a result, the FTSE EPRA Nareit Global Reit index fell around 15%, while the FTSE EPRA Nareit UK Reit index plunged about 31%, according to Numis analyst Andrew Rees who published a report last month.

Rees said the pressure on commercial property was ‘set to continue as the market establishes an acceptable premium to the risk-free rate’ of government bonds. Although UK gilt yields recovered from the sell-off provoked by former chancellor Kwasi Kwarteng’s ‘mini’ Budget in September, they still advanced from under 1% to 3.2% last year. 

The negative sentiment toward the asset class was compounded by open-ended funds forced to sell their best properties and suspend redemptions as investors headed for the exit.

While this inevitably drew comparisons to the 2008 global financial crisis, Rees did not think the situation was that bad. He pointed to ‘robust’ tenant demand as high inflation held up the construction of new developments and the fact that the closed-end funds under his watch enjoyed much stronger balance sheets than during the credit crunch.

‘We take comfort that most property investment companies have a high proportion of fixed-rate debt and notable loan-to-value headroom,’ Rees said in relation to the escalation in finance costs.

Given those positives, he believed Reits were trading at ‘unjustifiable discounts’ with the average Reit share price trading 28% below net asset value (NAV). In his opinion, this showed markets had ‘already priced in that a significant downside scenario will be borne out’.

For bargain hunters looking for high yields and comfortable with a risk of capital loss, Rees shares the following picks. 

Custodian Property Income (CREI )

This £440m portfolio, a corporate broking client of Numis which last month changed its name from Custodian Reit, focuses on smaller commercial properties outside London and the South East that offer an ‘income advantage without additional property risk’, explained Rees.

This has allowed fund manager Richard Shepherd-Cross (pictured) to deliver high and stable dividends currently yielding just over 6%, which Rees said in the current environment was ‘increasingly attractive’.

As the investment trust had not benefited from ‘yield compression’ and price rises as much as funds investing in larger ‘prime’ properties, it was less vulnerable to the squeeze on valuations.   

Rees added that the closed-end was ‘relatively insulated’ from rising debt costs with a conservative balance sheet that showed a low loan-to-value of 24.3% and had 84% of its debt on a fixed interest rate.

‘We therefore believe the fund is well placed to maintain its attractive earnings generation and fully covered dividend, and we view the current rating – 20% discount to September NAV – as undemanding,’ he said.

Schroder Real Estate (SREI)

With a £215m market value, this is the smallest Reit picked by Rees but he believes it merits a ‘trading buy’ on account of a number of advantages and a wide 34% discount (that has subsequently narrowed to 29%).

A key advantage is low finance costs of 2.5% following its then painful decision in 2019 to incur a £26m break fee and re-set its borrowing over a longer period and lower interest rate. While at the time this knocked NAV and investor sentiment, it meant that 78% of borrowing costs were now fixed and there was no refinancing risk on the horizon.

The refinancing helped the company deliver a progressive quarterly dividend that at 0.803p per share was 4% ahead of its pre-pandemic level, and offer a yield of just over 7% that was covered 1.1x by earnings in the half year to September.

Fund manager Nick Montgomery (pictured) had proved successful in asset management, said Rees, citing the example of the Stanley Green Trading Estate in Manchester, which had been refitted to be carbon neutral and re-let with its value rising from £17.3m to £29.5m in two years.

Possible catalysts for a re-rating, said Rees, ‘include further earnings and dividend growth underpinned by low cost of debt, as well as the scope for further selected disposals to crystalise value that surprises to the upside.’ 

LXi Reit (LXI )

LXI, whose merger with rival Secure Income last summer beefed its market value to nearly £2bn, is Rees’ preferred pick among long-dated property income funds, particularly as – following a de-rating in September – its shares trade on an attractive 18% discount to NAV.

The analyst considers LXi a ‘core buy’ with a portfolio of ‘business-critical assets delivering a high proportion of inflation-linked income which will underpin rental growth’.

On top of this, its 13 distinct sub-sectors should provide ‘downside protection’ for investors.

The fund’s ‘dynamic’ management team of Simon Lee (pictured) and John White has, Rees said, ‘consistently generated returns ahead of target and we believe the recent merger with Secure Income will open up more accretive acquisition opportunities’.

LXi had to abandon an acquisition of a portfolio of Sainsbury’s stores when its shares tumbled below asset value. It also faces a refinancing risk with £734m of borrowings due to expire this year and next. Although it recently hedged some of its loans, borrowing costs are certain to rise, potentially crimping earnings, said Rees, although its larger size could help secure better terms from lenders.

Industrials Reit (MLI )

The £390m portfolio, another Numis broking client, is the only UK Reit focused on multi-let industrial estates following a four-year transition away from its roots as a European property generalist.

With a ‘bespoke operational platform and pioneering management team’ led by chief executive Paul Arenson (pictured), the closed-end fund is ‘a compelling proposition’, said Rees, especially as its shares trail on a 21% discount to NAV.

MLI’s estates typically comprise between five and 50 units that are rented by a diverse range of businesses. The strategy is paying off as there is a dearth of multi-let industrial supply, which has driven strong rental growth. Rees believes this ‘can be sustained through more challenging economic conditions given the breadth of new “modern use” occupiers’.

‘With a robust balance sheet and low interest rate exposure, the company is defensively positioned to ride out near term uncertainty,’ he said.

‘This will leave it well placed to deliver on the compelling opportunity set as markets stabilise. At current price shares are yielding 5.3%, which we view as an attractive entry point.’