The UK property sector has experienced a mixed couple of years. The EU referendum seems to have caused investor confidence in the sector to decline, with the outlook for the UK economy now being less certain than it was previously.
Property prices could come under pressure in the near term. However, the valuations of these two real estate investment trusts (REITs) appear to factor in further challenges for the sector. They could therefore provide a high total return in the long run.
The UK commercial property market faces an uncertain future. Recent developments regarding talks between the UK and EU have suggested that progress has been made on the prospect of a deal between the two sides. However, there is still a very long way to go until a formal agreement is signed, and there remain potential issues surrounding the terms of trade which will be in place beyond March 2019 or any transitional period thereafter.
This uncertainty could have a destabilising effect on the performance of the UK economy. In turn, it may cause demand for commercial property to decline. This would be likely to hurt the valuations of properties across the UK, and this could impact negatively on the performance of the REIT sector. Therefore, for many investors it may appear to be a sector to avoid ahead of what may prove to be a volatile 15+ months for the industry.
Margin of safety
However, investors appear to have already factored in potential challenges regarding Brexit and the future performance of the UK economy. Specifically, valuations across the REIT sector suggest that there are large margins of safety on offer. This could mean companies operating in the commercial property space both inside and outside of London may deliver total returns which are better than many investors anticipate.
Valuations across the REIT sector suggest that there are large margins of safety on offer.
For instance, Great Portland Estates (LON:GPOR) and British Land (LON:BLND) are two FTSE 350 REITs. They have extensive commercial property interests, with the former being focused on London’s West End and the latter having a greater geographical spread across the UK. Both have asset bases which include various prime properties in historically desirable locations. Yet they have price to book value (P/B) ratios of only 0.8 and 0.7 respectively.
With both companies trading at well below net asset value, it suggests that investors have already priced in potential falls in property values. Even if that situation arose and demand for commercial space declined, the two stocks may not deliver significant share price corrections. And if Brexit talks progress smoothly and/or leaving the EU does not harm the performance of the UK economy, the prospect of capital gains seems high.
As with any industry, there are inevitably peaks and troughs. The present time could be considered a more challenging period for UK commercial property. However, with high occupancy rates, falling debt levels and enviable portfolios of high-quality assets, British Land and Great Portland Estates seem to have investment potential for the long term.
For more property investment ideas, enter your email address below to never miss an issue of Master Investor Magazine.