Shares digital

Following a dire performance last year, FTSE 350 real estate firms are gradually clawing their way back into the market. Over the past year, company share prices have nosedived as yields have moved out causing property values to take the plunge. Continued uncertainty and a cautious outlook have repeatedly dragged down confidence levels, suggesting that the property sector is in for another rough ride this year.

Yet despite such gloomy forecasts and negative sentiment, what has been surprising is that since the start of 2008, FTSE 350 property company share prices have gently started to climb the mountain they slid down last year. Furthermore, they may get an additional boost from M&A activity this year.

With many companies now trading at a large discount to their net asset value, experts are debating whether this will lead to a flurry of M&A activity later in the year as large cash-rich companies hunt out cheap deals. Opportunities like this don’t come along every day and as a result, certain companies will more than likely jump at the chance to take advantage of the situation.

Larger companies on the FTSE 350 index, which have a decent sized cash pile, will no doubt start to look for smaller businesses to add to their portfolios. In addition, larger companies overseas are likely to start mulling bids for those groups that thought they were the ones doing the buying. Already, a handful of companies have been placed in the takeover firing line, such as Mapeley and Hammerson, but as yet nothing has come to fruition.

Transaction inaction

For the moment, however, one problem that continues to plague the sector is the lack of completed property transactions. With few deals being carried out, the property market has been left in a state of limbo, and knowledge about what is actually going on is sadly lacking. In turn, insufficient clarity about the market situation means that hardly anyone wants to take the risk of carrying out a deal, bringing us back full circle.

This continued uncertainty has led many people to believe that the property market should be completely avoided. Certainly, if you are not one to take risks then steer well clear. But a more open-minded view would be to not tar every single FTSE 350 real estate firm with the same brush. Not every company operates in exactly the same market, and as a result, recent events have hit some firms harder than others. Those with a stronger business model should still see some solid growth this year.

Niche winners

FTSE 350 real estate companies operating in particular niche sectors are certainly ones to watch out for. The self-storage market, for example, represented here by Big Yellow, is certainly one area which looks set to be going places.

Although this market has not remained immune from the effects of the credit crunch, and Big Yellow’s share price has still suffered, the sector is more resilient due to the fact that people require storage space no matter what market conditions are like. Whether or not they can afford it is another matter, but in more mature markets, such as the US, the self-storage sector has been shown to continue to grow through several economic and housing downturns. With the UK market currently so immature compared to the US and Australia, the growth potential is huge.

Another market which should hold up pretty well is the student accommodation market, represented here by UNITE Group. (See Rising Star page 38). With the student population set to increase by 7% in the next nine years, demand for accommodation is set to remain strong. Increasing demand from international students studying in the UK is also helping to buoy the market and the outlook is promising.

The Reit stuff

Real estate investment trusts (Reits) are also worth a mention. Out of the 21 property companies listed on the FTSE 350 index, ten have converted to Reit status since January 2007. These are Big Yellow, Workspace Group, Shaftesbury, Brixton, Great Portland Estates, SEGRO, Hammerson, Liberty International, British Land and Land Securities.

Aside from the obvious tax benefits of converting to a Reit, part of the incentive behind the idea is that the company can often end up trading at a premium to its NAV. So far, however, this has yet to happen. Critics have quickly swooped in to bad mouth the concept of Reits despite this being a little unjustified and premature, considering the introduction of Reits to the UK has only recently passed its first birthday.

The US, meanwhile, has had success with Reits for 45 years and the Australian market is also well established. Both of these countries have taken years to develop Reits and although they are now proving very successful, the UK market is significantly immature in comparison. As a result, Reits look set to be packed with potential for the future.

Of course, recent events have led to tighter lending conditions, meaning that those property companies with strong balance sheets and good relationships with their lenders will fare more favourably than those that don’t. Some property firms are also benefiting from increased levels of distressed sales, enabling them to purchase property at considerably cheaper rates and boost their land banks.

Companies such as Derwent London, Shaftesbury and Great Portland Estates which have a specific focus on the West End London market should also be more resilient in more challenging conditions thanks to strong demand and limited supply in this area.

But this can no longer be applied to the London market as a whole. Compared to the stability of rents across the UK over the past year or so, in general, rents in London have risen. Confidence surrounding rental growth in London is now starting to slip though, and analysts believe that London office and retail warehouse markets are likely to see rents fall.

Analysts at Lehman Brothers are forecasting that rents in the City office market are likely to fall 15%, while retail rents could fall 10%. An expected increase in redundancies in the City, as companies attempt to cut costs, also won’t help London offices. And a deterioration of the London market is unlikely to bode well the the rest of the UK real estate sector.

Overall it is pretty safe to say that 2008 is not going to be a spectacular year for FTSE 350 real estate firms and the property market is likely to get worse before it gets better. Without getting too pessimistic, there may still be a silver lining. Those companies with low gearing, solid management experience and a more diverse portfolio are most likely to be the best bet this year, alongside those that operate in the more resilient, niche markets.

KEY INDICATORS

The economics: GPD

• Unemployment/job growth

• Interest rates

• Retail spending figures

• Number of property transactions

• Average house price

• Competition for land

• Supply and demand balance

TOP ANALYSTS

Top of the tree

Nan Rogers – Arbuthnot Securities

With 26 years of property experience under her belt, it is not surprising that Arbuthnot Securities’ Nan Rogers has clinched the number one spot. Rogers’ career started in 1982 at Grenfell and Colegrave, which was taken over by CIBC in 1986. From there she moved on to James Capel (now HSBC) in 1986 until 1991 when she moved to Charterhouse which then became ING.

In 2002 Rogers moved to Bridgewell for three years until she took up her current position at Arbuthnot Securities. When asked what she thinks makes a good analyst, Rogers simply replies that it comes down to ‘trying to keep on top of things, explaining them, learning, being prepared to be wrong and admitting you’re wrong.’

Regarding the outlook for the FTSE 350 property sector this year, Rogers believes the market is in for a ‘fairly dull time’. Although the adverse movement in yields is now slowing down, she points out that there is a risk that rents could fall, particularly in the London office and retail warehouse markets. London offices are also set to be hit by rising levels of unemployment in the City on the back of the credit crunch.

Despite this, Rogers believes there is some value to be found and those investors who successfully pick the safer stocks should simply hold on to them for now. Those companies that are not highly geared and can therefore take advantage of distressed sells will be less at risk than those that are highly geared, particularly if they are also supported by an experienced management team. Top picks in the FTSE 350 include Land Securities, Hammerson and Shaftesbury.

Safe as houses

Harm Meijer – JPMorgan

Having moved from ABN Amro to JPMorgan in 2005, Harm Meijer has been covering the property sector for eight years, giving him plenty of experience.

To become a good analyst, Meijer believes it is important to keep on top of things and follow companies carefully. He adds that it is also important to be willing to ‘put a view forward and stick to it, be willing to say something different, and do your homework.’ Regarding the outlook for the sector, Meijer believes that certain stocks in the UK property market currently look quite interesting, although the whole sector still looks vulnerable in the short term.

More optimistic than some, Meijer believes there will be some good entry points in the coming months, adding that in general, the UK has better quality companies. When asked what makes a good company, Meijer points to those firms that have a management with a clear strategy and focus and a quality portfolio.

Top picks in the FTSE 350 index include Land Securities due to its relatively low financial leverage and strong management, but he also highlights Capital & Regional as an opportunity play. As to whether there will be an increase in merger and acquisition activity in the sector this year, Meijer believes this won’t happen, or at least not until the second half of the year. For the moment, he says it is too early to say.

A money man

Mike Prew – Lehman Brothers

‘I think my competitive edge is from coming outside the real estate industry,’ says Prew. ‘I am the only sector analyst who has been to business school, set up a Jersey Trust and sat on the board of a private real estate company and had to answer shareholder questions.’

Prew graduated with a BSc (Hons) from Imperial College, University of London, and a Masters degree from its business school. He has more than fifteen years’ sector experience, principally specialising in UK Reits. Prew joined Lehman Brothers in 2006 where is currently an executive director and heads the European Real Estate team. His previous employment includes CSFB, where he led the $1 billion Canary Wharf Group IPO, and also Citigroup where he executed the $600 million Hammerson placing.

According to Prew, the key attributes of being a good analyst are ‘curiosity, ingenuity and a financial rather than asset approach to the sector which adds more value than the descriptive/maintenance product which is no more than chewing gum for the eyes.’

Looking at the property market, Prew says that last year property prices and Reit shares went through a capital market derating. ‘In 2008 we expect the second leg of a double dip devaluation with occupational markets in recession led by rents falling in the City office market and retail under pressure especially in the warehouse sub sector.’ He adds, ‘The decks are being cleared for the next cycle. This one is over.’

STOCK FOCUS - BEST BUYS

Locked up - Big Yellow

The self-storage firm joined the junior market in May 2000 and moved to the main market in 2002. Following the company’s flotation, the shares performed tremendously, reaching a high of 705p at the start of 2007, against its closing flotation price of 122p. However, that signalled the end of a faultless performance, as, being lumped in with all real estate stocks, the shares tumbled last year.

Since the start of 2008, the shares have started to regain lost ground and the group’s ambitious expansion plans should help to support further growth. Big Yellow plans to open between six to eight stores per year, with the number of stores currently open and sites in planning or under development (including five in the Partnership) coming to 73. Most of its stores are owned freehold, with the majority located within the M25. The group also converted to a Reit in January 2007.

Big Yellow should also benefit from the less cyclical nature of the self-storage market compared to the real estate sector as a whole, as has already proved the case in more mature markets such as the US, where the self-storage sector has continued to grow through several economic and housing downturns.

However, it does suffer from seasonality issues, with the winter months less profitable due to lower occupancy rates. Competition for land could also eventually hamper expansion plans, although it has been argued that the market is currently too immature for competition to be an issue. With a more resilient business model and great growth potential, the company is a very attractive buy.

Landed gentry - Land Securities

This is a stock which seems to be particularly favoured by analysts and it is easy to see why. Land Securities is Britain’s largest commercial property company, with a portfolio of commercial property worth over £14 billion. The company’s investment portfolio also has around 60 retail parks and shopping centres including Birmingham’s Bullring centre and Exeter’s Princesshay site and around 50% of the portfolio is in London.

Despite recent turmoil in the market, the company successfully posted a 55p hike in its adjusted diluted net asset value (NAV) to £22.36 at its interims last November. Analysts at Lehman Brothers are forecasting a 2008 year-end NAV of £19.17 and £18.54 for the year ending 2009. Land Securities is also in the process of dividing the business into three specialist entities – Retail, London, and Property Outsourcing.

It is likely that this break up will lead to a spate of takeover activity for each separate company. Of course the company doesn’t come without risks, with analysts at JPMorgan pointing out that the company’s share price would be ‘negatively impacted by disappointing office rental growth in London, which would hurt the performance of its (standing) office investments and development pipeline.’

A further weakening of the UK retail market would also affect Land Securities’ property performance. However, the company has a strong balance sheet and is generally regarded as a safer bet.

Village people - Shaftesbury

Shaftesbury benefits from investing only in those districts within the West End where demand from occupiers is strong. The company owns a portfolio of over 400 properties, with all of its investments being located near shops, restaurants, theatres, cinemas, galleries and museums.

Supply in the area is also constrained, providing Shaftesbury with the perfect demand/supply combination. Analysts at Lehman Brothers believe the group has ‘created a monopoly ownership model with one of the most concentrated estates in the UK real estate sector.’ Its portfolio of ‘villages’ in four West End locations is also likely to be difficult to replicate, putting Shaftesbury in a advantageous position.

Analysts at Cazenove add that ‘while London might pause for breath following the credit market problems it has numerous positive growth catalysts medium/long term in our view and we believe Shaftesbury is extremely well placed to capitalise on this.’ At its year-end results the company posted pre-tax profits of £124.2 million against £187.6 million the year earlier. Its adjusted diluted net asset value per share, meanwhile, was up 56p (9.5%) at £6.46. As at 30 September 2007, its property portfolio was valued at £1,394 million.

The company does of course have risks, with Lehman Brothers pointing out that the company is ‘heavily exposed to tourism and footfall level and therefore acts of terrorism, sustained transport disruptions, etc, pose a greater threat to the company than near-term market fluctuations.’ But overall, its unique position and stable cash flows make the company an attractive investment.

STOCK BUYS - STEER CLEAR

Dented value - British Land

Along with many property companies, the real estate giant’s share price was hit hard last year, tumbling 45% to 945p, and it has yet to show any significant signs of recovery. The company took another hit when it reported in February that the value of its property portfolio had been slashed by almost 9% in the three months to December. Its net asset value per share also slumped 16.7% to £14.01 as a result of a widening of the market value discount to assets.

Previously, at its half-year results, the group had said its NAV had remained unchanged at £16.82, prompting Lehman Brothers to cut its British Land rating from equal-weight from overweight. At the time, Lehman Brothers’ Mike Prew said the company’s ‘governing dynamics are flat and earnings are positioned defensively, but this was as close to an NAV warning as the sector comes.’

The broker has since downgraded the company to underweight. Lehman Brothers is forecasting a year-end NAV of £13.06 and has also pointed to the fact that the group is losing London office human development capacity. On a more positive note, British Land has enjoyed ‘exceptionally’ strong occupancy levels, with 99% of its portfolio let and an average lease length of 14 years. It is also making good progress with its development plan and has £2 billion of committed undrawn bank lines available as opportunity arises. It also recently agreed to create a £1.2 billion joint venture property partnership with Sainsbury incorporating 39 superstores across the UK. But for now, it looks too high risk and is worth avoiding.

Weaker by the day - Brixton

Its share price plunged almost 50% last year and full-year pretax profits fell heavily to £58.2 million against £205.1 million the year earlier. However, its adjusted net asset value per share beat analyst expectations, rising 2.1% to 545p. Back in 2006 Brixton chose to sell most of its secondary property and to look selectively at making prime acquisitions in its core markets of West London and Trafford Park in Manchester, a wise move.

Although the group has been enjoying strong rental growth, chief executive Tim Wheeler has warned that occupational demand could be hampered by slowing growth rates and availability, and pricing restrictions on finance. Analysts at Cazenove say the portfolio is ‘plagued by high vacancy... cash generation of this stock is limited’ and the outlook for cash flow is weaker.

The recent withdrawal of empty rate relief is also expected to severely effect Brixton’s earnings which it estimates will be around £5 million for 2008. House broker Lehman Brothers is also forecasting that its NAV will fall to 494p in December. ‘The shares trade at a 37% discount against the sector average discount of 20% and at 12 months, 32% discount versus a sector discount average of 17%,’ the broker says.

The price of a fall - Capital & Regional

This co-investing property asset manager manages property assets for funds in which it holds a significant stake. This enables its equity and management to be leveraged over a large portfolio. Last year, the company made no major acquisitions and instead made two disposals to reduce its fund’s gearing.

It also increased its German portfolio to 50 properties, valued at £490 million. But its performance against the sector as a whole has been poor. ‘The share price’s dire performance last year owed more to the group’s high leverage and concerns about LTV covenant breaches than it did to yield expansion risks to its asset base,’ say analysts at Cazenove. They also point out that the share price has fallen by 57% since 1 July 2007, (£11.63 to 495p in February 2008), ‘underperforming the sector by 48%, and the wider equity market by 54%.’

For 2007, the group posted a pre-tax loss of £166.8 million (which under IFRS rules includes the unrealised valuation deficit) against a profit of £222.3 million the year before. Meanwhile, the weakness of UK property valuations, the impact of gearing in a falling market and the claw-back of performance fees led to a reduction in triple net NAV per share to £10.04 per share, against £12.72 per share a year earlier. With an uncertain outlook, this is one to avoid.

RISING STAR

Allan rules the roost

UNITE have the student accomodation market all wrapped up

Compared to some of the big guns in the FTSE 350, student accommodation firm UNITE looks considerably smaller with a market value of £419.6 million. It is in fact the largest provider of student housing in the UK and its growth potential is substantial.

The business was founded in 1991 and floated on Aim in 1999. The following year it was bumped up to the main market. Then, in September 2006, Mark Allan was appointed to the role of chief executive, having previously been the group’s chief financial officer for three years.

At the start of 2007, UNITE set a growth target to double the net rental income from its student portfolio within five years, and through the group’s ongoing development activities the portfolio is growing by around 3,500 new bed spaces per year. Allan is confident of the company’s future success and points to three key drivers of the company’s growth.

Firstly, the UK demographics are favourable – the 18 to 30-year-old population is set to increase by 7% over the next nine years. Secondly, government policies are encouraging younger people into higher education. There are currently around 2.4 million students in UK higher education, with 1.4 million being full time. Out of this number, around 1.1 to 1.2 million require student accommodation. Thirdly, there is increasing demand from international students studying in the UK. Many of these students come from India and China, but there are also a rising number of students coming from EU countries such as Cyprus.

Allan explains that the UK is an attractive country to international students because of the value of an English-taught degree. Of course, London in particular is a favoured destination, providing a supply/demand imbalance for student accommodation.

Students in London account for 10% of the total numbers living in rented accommodation in the city. The London full-time student population is greater than all the full-time students in the next four largest markets in the UK combined.

CHARTING THE SECTOR

Real Estate wobbles

Earlier positive signs have faltered. Bulls should proceed with caution

by Simon Griffin

Despite the severe sell-off through 2007, at the turn of the year, the chart offered hope. The index retraced to a test of the Fibonacci ratio-derived 61.8% of the 2003-07 bull run, during which the index multiplied by two-and-a-half times and outperformed the the FTSE 100 index by some 80%. The hope was the combination of this key retracement and historic congestion, evident in much of 2005 around the 3,200 level, would end the selling. On the back of positive momentum divergence, the index has attempted to rally. However, it remained shy of the 200-day average (currently close to 3,810) as it made its best levels at the start of April.

Regaining this important average will be key to establishing a new uptrend, so while we can tentatively pencil in the beginnings of a new bull channel, recent renewed weakness has seen the index drop to test that channel’s baseline at 3,336, not so far from a retest of the recent low at 3,236.

Ideally these levels must hold if the index is not to take further significant loss, for the alternative view is that what appears to be a base is really a mid-move bear flag pattern, possibly pointing to a test of the 2003 lows. However, until we see a close below 3,170, the possibility of a recovery remains.

A brave strategy would be to buy but to have protective stops if not stop-and-reverse orders close below this latter level.

F&C Commerc. Prop. Tr. (FCPT)

BUY - 99p

TARGET - 118p

STOP LOSS - 93p

This chart epitomises the decline in the past year, particularly in commercial property-focused investments. On a simple technical study it is clear the market lost momentum and rolled over in 2007, giving an opportunity to take profits.

The 200-day average was key, protecting the downside in the rise. But when the shares broke below the average in late summer, then achieved a dead-cross signal as the 50-day average crossed below the 200, it then switched roles, giving terminal resistance to corrective bounces. Currently this key average coincides with Fibonacci 38.2% retracement at 105p and would be expected to offer resistance on gains.

The shares seemed to bottom in the new year, after bullish momentum divergence, and have now formed a diamond pattern, usually seen at major turning points, which heralds a 16p move.

The break has come to the upside, so potential for a move to 115p should be pencilled in. Initially, however, this would require a break above that 200-day average and congestion close to 109p. But such a move would take the shares close to the Fibonacci 61.8% retracement of the sell-off, at 118p and probably also close to the bear trendline drawn off the descending highs in 2007. However, should selling reappear and take the price below 93p then expect the January 85.5p low to be retested.

Capital & Regional (CAL)

BUY - 428[

TARGET - 750p

STOP LOSS - 340p

The shares peaked at £16.95 in February 2007 and lost over 80% of their value by the year end. The 200-day moving average (green line) supported the rise from 2003, but the 50-day average capped the more recent downmove.

Yet the level the shares based at in early January was where the super-long-term bull trendline, drawn off lows in 1995 and 1998, came in; and was near congestive resistance that ended uptrends in 1998 and 2003. Clearly 328p represented major potential support, helped by some positive momentum signals. The subsequent bounce achieved a break above the 50-day average but stayed shy of the 200-day line.

Now a slip back has worried doubters but has so far stayed above 61.8% retracement of the 328p-579p bounce. Such corrections can come close to testing lows (328p in this case) as the market prepares to trap bears. But if the shares can hold above so doing, then much of a decent upmove is there to be taken.