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03 May 2024

Consolidation in the REIT Sector

This article was taken from the March 2023 issue of Market InsightTo subscribe to our investment publications, please visit www.redmayne.co.uk/publications
 
2023 proved to be a lacklustre year for Real Estate Investment Trusts (REITs), especially so when considered against certain equity and fixed-income sectors, which offered historically attractive levels of income and capital appreciation.

A combination of macroeconomic factors and poor investor sentiment to the sector has resulted in discounts becoming widely available. At the time of writing, Tritax Big Box shares trade at a discount of c18% to Net Asset Value (NAV) cand Primary Health Properties at c15%. Having historically traded at premiums, the downward slide of share prices in the sector has been a pain point on portfolio valuations. On the flip side, the wide discounts offer a potentially appealing entry point for income seeking investors. It is not just investors who are drawn to the current discounts on offer, many property funds have also been seeking out opportunities to purchase entire portfolios for a relatively cheap price, leading to an uptick in Merger and Acquisition (M&A) activity this year.

LondonMetric for one, is no stranger to snapping up competitor portfolios, with a string of acquisitions in recent years, recently acquiring CT Property Trust for £200m in 2023 to take the total combined portfolio to £3.2bn in size. LondonMetric CEO Andrew Jones was not done there though and endeavoured to go after a much bigger catch, namely its peer, LXI REIT. A £1.9bn acquisition offer was sufficient to sway over the LXI shareholders, with the merger finalised on the 6th March 2024 to create a combined entity with a portfolio value of £6.2bn. The move also marked the creation of the UK’s largest triple net lease focused REIT. For those not familiar, a triple net lease is an arrangement whereby the tenant is responsible for covering all, or most of, the costs related to the rented building, such as insurance, taxes, and maintenance. This structure can be particularly advantageous to the landlord given the potentially significant reduction in operating costs.

As a result, LondonMetric has been able to keep expenditures substantially below that of its peers, with a costing ratio (operating expenses as a percentage of gross rental income) of 11.5%, compared to the sector average of 24.5%. The new entity will be managed and administered internally, enabling the REIT to axe LXI’s investment management agreement with the prior manager. This decision will create cost savings of £13m per annum, helping to bring the costing ratio further down into the 7-8% range by 2026, and improve alignment between management and shareholders.

Merger synergies are also conducive to improvements outside of the company’s cost base. Greater scale offers improved liquidity and potentially draws in a wider range of investors. Alongside the improved access to debt markets and lower debt costs, there is also a wider range of potential financing arrangements.

It is unsurprising then to see others within the sector watching with interest, waiting to get in on the merger action. Tritax Big Box, the industrial logistics focused company, is the latest significant player in the industry to try its hand at merger activity, with a proposed takeover of UK Commercial Property REIT (UKCM) announced recently. Both have significant exposure to logistics assets, making the portfolios broadly complementary, but with 40% of UKCM’s portfolio allocated to non-logistics assets in areas such as retail and student accommodation, a few eyebrows might be being raised. Another point of interest crops up in the deal, the composition of the shareholder register. Nearly 60% of the UKCM shares are held by two institutions, which quicky followed the announcement with their own letters of support. This poses a question as to whether the Tritax team are acquiring the best portfolio possible or simply the easiest one.

While the larger players in the sector are seemingly making things look easy, in the mid-range of the REIT space, activity requires the boxing gloves to come out, with competition intense as vehicles struggle to complete the task of acquiring peer portfolios at attractive valuations. A prime example of this is the battle between Urban Logistics REIT and Custodian Property Income REIT (CREI), both competing to acquire Abrdn Property Income Trust (API). Despite Urban Logistics’ offer coming in at a 13% premium to CREI’s bid, the API board has urged shareholders to back a merger with CREI instead, citing how a tie-up with the latter represents “a strategically consistent and significant enhancement to the status quo for API shareholders.” API shareholders are to decide on both proposals in late March.

Clearly, the recent macroeconomic environment has not been particularly pleasant for REITs. Resetting property yields, concerns over higher debt costs, poor investor sentiment, and abundant opportunities for yield elsewhere have all proven to be headwinds. However, consolidation induced by these circumstances is undoubtedly positive for the sector. The merging of smaller REITs into larger entities brings about various benefits, such as cost-savings and liquidity, as seen in the examples above. This, together with the prospect of future interest rates cuts, renders the larger REITs more viable for investors from a liquidity, income, and capital appreciation perspective. Consequently, some leading REITs are now well positioned to benefit from a potential reversal in macroeconomic conditions and sentiment in the medium-term.

Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned. Investments and income arising from them can fall as well as rise in value. Past performance and forecasts are not reliable indicators of future results and performance.
 
 
 
 
 
Consolidation in the REIT Sector

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