Listed London office owners will need to embrace “change and innovation” as the market resets, according to equity analysts at investment bank Berenberg.
In a new note, analysts Miranda Cockburn and Yudith Karunaratna said they are “optimistic” about the long-term outlook for London office-focused REITs.
“While the office market clearly has its issues, it does have a place in the property market, just in a different format,” they said. “This means change and innovation, which is a trait that has long been displayed by the London office REITs.”
Cockburn and Karunaratna said the challenge will be that office owners will remain low yielding and continue to be a total-return proposition.
“Therefore, rental growth and value creation are vital to providing the type of attractive NAV total returns generated by the companies prior to 2016. This is unlikely in the near term,” they added. “While we see the potential for the companies to re-rate positively and be dragged up by the rest of the UK REIT sector over the next year, our forecasts are suggesting limited growth.”
The bank has “hold” recommendations on GPE and Derwent and “buy” ratings for Helical and Shaftesbury Capital.
Earlier this month, TR Property Investment Trust fund manager Marcus Phayre-Mudge told EG that smaller REITs trading at big discounts to asset value were likely M&A targets.
“If you have lost that gravitational pull [between share price and NAV], you are what we call space junk, you are just sort of floating around out there,” Phayre-Mudge said, adding: “If the stock market is going to be too miserable about real estate and allow the share prices to drift to these big discounts to the asset value, then private capital will come in and take them out.”
Cockburn and Karunaratna said in their own note: “While central London office values have declined by 30% in the City and 16% in the West End from the peaks in June 2022, according to MSCI, we believe that, if one were to truly mark-to-market London offices today, the decline would be greater.
“In our view, this is where the stock market is able to price more efficiently than the direct property market – by moving the shares to discounts to NAVs… Until confidence returns to the wider UK property market and, specifically, there is a more positive outlook for the office sector – which may take a while given weak economic growth – we expect the London REITs to trade at a discount.”
The Berenberg team said grade-A rents are clearly rising but noted that leasing is taking longer and that “even within the best buildings, there are hot and cold spots”.
“Active demand remains buoyant, with more companies seeking to expand than contract, countering claims of the death of the office, although increased flexibility at the small end of the market is now non-negotiable,” they said. “Therefore, we believe that there is no debate as to whether prime rents can grow from here. The issue for GPE and Derwent is the portfolio effect of owning both the weak and the strong, which will dampen returns at the company level.”
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