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The Reit generation

One year into the UK Reits regime, many of the property companies which converted to Reits in January 2007 are publishing annual results or quarterly updates.

These findings reveal key facts about Reits’ ability to weather the current market conditions that financial advisers should understand – even if they prefer to recommend to clients funds that invest directly in commer- cial property.

Importantly, the results season also highlights the impact that the Reit regime has had upon those who have converted, providing valuable lessons for investors. The general consensus from the majority of analysts is that UK Reits are well placed in today’s difficult market conditions. They own much of the best commercial property, have blue-chip clients and are not yet seeing falls in tenant demand.

As a stockmarket-listed vehicle, another positive for Reits is that they do not suffer from the structural illiquidity of open-ended vehicles. They are, of course, subject to falling property values and while the past nine months have seen rapid and major falls in share prices, they now seem to be staging a moderate rally.

In fact, UK property shares have risen by 15 per cent during the last two months although there is debate as to whether this is sustainable.

Over the last year, other changes resulting from the UK Reit regime are also now becoming clear. For example, one of the forecasts made when Reits were launched was that there would be significant M&A activity, which has not happened to date. Most obviously, this is a result of the credit crunch and possibly because, until recently, there was uncertainty about how takeovers would fit with the CGT write-offs obtained on entering the Reit regime.

That has not stopped frequent M&A rumour, however, and it may be of some comfort to those holding shares in UK Reits to look at the impact of takeover rumours on prices.

While it is possible to purchase a few thousand Reit shares at significant discount to net asset value, it is equally true that the price that would have to be paid to acquire that Reit would be a very much higher. The rise in the stock price of Liberty International at the start of March on the slightest of rumours of a takeover is a good example of this, as had been previous movements at Hammerson.

More importantly, UK Reits are not in the position where they are likely to have to sell out. They are relatively lowly geared – a requirement of the regime – and as they are now predominantly invested in by asset owners and managers, they are not dependent on sales of future development.

Market pressures are certainly forcing Reit managers to focus on delivering value from their core business and there were early predictions – based on US experience – that Reits would have to focus on specific sectors rather than diversify, as the biggest UK property companies had historically done. This appears to be borne out by Land Securities proposed break-up into three parts; focussing on retail, London offices and outsourcing through the Trillium operation.

All the sectors above are likely to trade as Reits and their potential strength has been shown by the announcement before Easter that Trillium had successfully raised more than £1.1bn for an infrastructure fund. This huge achievement in today’s constrained markets illus-trates the value put on good management and good propositions.

Elsewhere, two of the strongest results from UK Reits were announced by Shaftesbury, which focuses exclusively on London’s West End, and by Brixton investing in the West London industrial market. Predominantly, this will be Park Royal and Heathrow – the powerhouse of the service-based economy in the UK and the location of the highest value real estate of its type in the world.

While focus is predominantly the result of management leadership, the pressure brought about by frequent reporting and constant monitoring by analysts and fund managers undoubtedly helps to make the quoted sector the most transparent form of property investment.

With Reits being the most globally common property investment vehicle, operating in some 20 countries, expectations were high that there would be an influx of foreign investors into the UK market. Early indications were that most overseas investors preferred Asia to the UK, both because shares in UK Reits were expensive and the dollar sterling conversion rate was so poor.

While conversion rates are still poor, with UK prices having fallen by as much as 40 per cent, they no longer look so expensive and there has been a steady inflow of foreign money.

Much is coming from the US and there has also been significant investment from Asia Pacific, with sovereign wealth funds being active.

The major UK Reits all now have significant non-UK shareholdings. In Brixton’s case, for example, this is reported as being at 52 per cent.

Finally, and perhaps of most direct interest to advisers and investors, the requirement for Reits to distribute 90 per cent of the profits from rental income is having its intended effect of forcing up dividends.

Where dividend yields pre- 2007 averaged about 2.5 per cent, most Reits are paying 3.5 per cent and some such as Primary Health Properties well over 5 per cent. But there is further to go, particularly for the majority who still have to pay a full year’s dividends under the Reit regime.

Although the capital value of UK commercial property may be falling, long-term leases, fixed borrowings and relatively low gearing ensure a predictable ongoing income stream that many might find attractive. This should also remind advisers and investors that commercial property is a total return investment. Providing income and some capital growth for long-term success, however, requires focused management, quality assets and blue-chip tenants.

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