In the days following the EU referendum, UK commercial property was the last thing investors wanted to hold. Various funds were suspended, commercial property stocks recorded vast share price falls and it seemed as though the sector was in for a rough ride. However, since then a looser monetary policy, weaker sterling and improved confidence surrounding the UK’s post-Brexit prospects has caused a comeback of sorts in commercial property stocks such as British Land.
In my view, this trend will continue since British Land offers good value for money, sound income prospects and most importantly, a bright post-Brexit future. Therefore, I believe it’s worth buying now for the long term.
Monetary policy
The Bank of England acted swiftly in the aftermath of the EU referendum. It reduced interest rates by 25 bps and outlined plans to initiate further QE. Although such policy actions have yet to make a tangible difference to the performance of the UK economy or commercial property market, they show that the Bank of England is likely to provide a relatively accommodative monetary policy over the medium term.
Although inflation is likely to rise from its current level of 0.9%, aided by a lower interest rate, the ultra-low cost of borrowing should mean that the UK’s retail environment remains buoyant.
This should help to boost confidence in the sector, while also making life easier for UK consumers. Although inflation is likely to rise from its current level of 0.9%, aided by a lower interest rate, the ultra-low cost of borrowing should mean that the UK’s retail environment remains buoyant. This is good news for British Land, since 49% of its asset base is in retail, with rent reviews being impacted by the profitability of its tenants.
Therefore, while there could be a period of uncertainty where inflation spikes and Brexit talks are proving difficult, consumer confidence could prove to be stronger than expected due to a dovish Bank of England.
Inward investment
Offices and residential property account for almost half of British Land’s asset base. Weak sterling should help that part of the business, since it will encourage increasing amounts of inward investment into the UK economy. The pound has already depreciated by 17% since 23 June and it would be unsurprising for it to fall further. As mentioned, an accommodative monetary policy alongside a hawkish Federal Reserve and concern about Brexit talks could hurt the pound yet further. This would make the UK an even more attractive place for companies, particularly those in the US, to do business.
That’s a key reason in my view for the recent announcements by Google and Facebook. Both companies are investing heavily in the UK, with the former creating 3,000 jobs and the latter creating 500 jobs. UK salaries will be lower than they were prior to the EU referendum, thereby making the UK more cost-effective on a relative basis. Investment from international companies in the UK should mean that demand for office space, particularly in London and the south east where 58% of British Land’s assets are based, increases over the medium term.
Brexit positives
While I expect Brexit to cause at least some uncertainty over the next couple of years as the UK and EU negotiate the terms of the exit, in the long run I believe that the UK economy will flourish outside of the EU. In fact, I don’t think that Brexit will have a major negative impact on the UK’s competitiveness, nor on its appeal to economic migrants. Therefore, the current forecasts for population growth in the UK of a rise of 440,000 people per annum over the next decade are likely to be met in my opinion.
Forecasts for population growth in the UK of a rise of 440,000 people per annum over the next decade are likely to be met in my opinion.
This should provide increased competition for space, in both a residential and commercial capacity. Therefore, I’m optimistic about the growth prospects for UK property in general, particularly in the south east where I feel that the UK will continue to have a competitive edge due to London’s status as a global financial centre. This could cause demand for British Land’s properties to rise and help to create upward pressure on rent reviews.
Low valuation, high income potential
As mentioned, commercial property stocks such as British Land have staged a recovery since initially falling following the EU referendum. Although British Land’s share price is down by 21% since the vote, it has risen by 9% since its low in the weeks after the UK voted to leave the EU. In spite of this, British Land offers appealing value for money in my view. It has a price to book ratio (P/B) of 0.66. This shows that even if UK property prices fail to rise over the near term, British Land offers medium term capital growth from a rising valuation.
Similarly, its income prospects are appealing in my opinion. British Land yields 4.9%, which is 120 basis points higher than the FTSE 100’s yield. British Land’s dividend coverage ratio of 1.2 is sufficient in my view to allow dividends to rise in-line with profit growth, since it requires less reinvestment than is the case for many of its FTSE 100 peers. As inflation rises in the UK, I feel that British Land’s high yield will become increasingly popular among investors.
Outlook
Commercial property is not a popular sector at this moment in time. Investors are nervous about Brexit and its potential impact on the sector’s performance. However, I believe that this only increases British Land’s long term appeal, since it has scope to rise in price by 50% and still trade below net asset value. When combined with a high yield, I believe that British Land has real investment appeal.
As inflation rises in the UK, I feel that British Land’s high yield will become increasingly popular among investors.
The UK economy may endure a rough patch, but the Bank of England seems content to adopt an accommodative monetary policy in future. The weakness of sterling may continue and encourage more firms to invest in the UK, while population growth over the next decade could increase competition for residential and commercial property. Therefore, in my view, Brexit provides an opportunity to buy British Land and profit from it over the long run.