In every seven to 10 year cycle there is a point when real estate looks good value. With property stocks some 40 per cent off their June 2007 peak, some believe that point is now, while others predict the downturn will see out the year.
While the global quoted real estate market rose 21 per cent in the last three weeks of March, this was a correction to a double dip in January and February. The average global Reit still stands at a massive discount of 36 per cent to NAV – compared with the long-term average 3-5 per cent premium. At yields of 7-8 per cent, commercial property is paying out over 5 per cent more than 10-year Treasury bonds – and this from stocks that have already proven they can endure difficult markets.
Further to fall
However, valuations could still conceivably fall by perhaps another 10 per cent over the next six months, as rental income comes under additional stress because of the broad economic backdrop and increased risk of tenant failures, in a further adjustment to a cyclical downturn.
Commercial property loans are going sour at an accelerating pace, threatening a second wave of multi-billion dollar losses to banks, according to data from Deutsche Bank. The delinquency rate on about $700bn (E540bn) in securitised loans backed by office buildings, hotels, stores and other investment property has more than doubled since September to 1.8 per cent, Deutsche analysts say.
“Global Reits are pricing in weak property fundamentals and the question is what will be the catalysts to drive a recovery off these low levels,” says Bruce Eidelson, a director of Russell Real Estate Advisors in San Diego.
“We think that the Nav numbers are reasonable and even if valuations come down further, there is still a good steep margin there. Reits may look to make dividend cuts to preserve capital, but spreads are currently much higher than the ten-year Treasury equivalent, and they would be able to absorb some downward movement and still provide a decent yield,” he says.
“The key issue is the refinancing risk,” Mr Eidelson adds. “Strong Reits can still access capital albeit at a higher cost but a number of Reits don’t have ready access to capital and are planning rights offers.” This bifurcation between the big quoted Reits, which are largely able to refinance, and the secondary, private property market, which may not be so fortunate, is a key characteristic of the sector.
“There are two distinct markets,” says Jakes Ferguson, partner and fund manager at Sarasin & Partners.
“There’s the quality end such as major shopping centres owned by quoted Reits like British Land or Liberty which in the main have good length leases to good quality tenants,” he explains.
“A number of Reits have been close to their covenants and have had to refinance but they have all been fully subscribed. We estimate that around £2.8bn (E3.14bn) of refinancing has taken place in recent months and this gives a good floor to the market.
“So the Reits story is that balance sheets look strong and there is no immediate threat regarding refinancing. In fact I believe many are now preparing to go on the offensive to acquire distressed assets,” adds Mr Ferguson.
“However, the secondary, private market has higher borrowing levels with 75-90 per cent gearing, or even 100 per cent gearing, compared with 45-50 per cent for the big Reits,” he says.
“When the smaller private market has come to refinance, in many cases properties have had to be handed back to the banks, which have found that the equity in these loans has completely disappeared,” explains Mr Ferguson.
The break-up of the Esporta fitness-club group bought by Simon Halabi is one example.
The luxury retail market is still signing new leases with good quality tenants, in shopping centres such as Cabot Circus in Bristol and Westfield in Shepherds Bush.
In Westfield, for example, Italian labels Pal Zileri, Fratelli Rossetti, and Frette have all signed up and a Louis Vuitton store is currently fitting out in time for a May opening. The upmarket Village part of the complex has seen the opening of 12 stores since the centre opened in October, including Burberry, Prada, Gucci, Versace, Ferragamo and Miu Miu.
Size no protection
However it is too simplistic to assert that the rental risk is concentrated in small retailers with two or three branches. Certainly, shares in the big commercial property firms jumped recently following a deal with national retail chains to cut service charges and rent by up to 20 per cent, as property investors acknowledged the risk that even big retailers could face administration.
