September was a bad month for stocks in general, but it was especially poor for UK REITs (real estate investment trusts), with 77% of the sector by market cap being derated according to analysts at Winterflood, leaving 24 out of 32 trusts down over nine months.

With worries over the economy, discounts to NAV (net asset value) continuing to widen and retail investors exiting the sector in their droves, we decided to dive into the recent updates from more than half a dozen REITs to see for ourselves what the current state of play is in commercial real estate.

The answer is not as bleak as the headlines, with almost all firms seeing strong rental growth along with high levels of rent collection and occupancy and some even suggesting the bottom may have been reached in for valuations.

APPROACHING A TURNING POINT?

Cyrus Ardalan, chair of LXI REIT (LSI), which owns a broad range of commercial property assets from hotels to car dealerships, care homes, discount retail sites and even theme parks, summed up the current situation: ‘The past six months have continued to be marked by considerable economic uncertainty, with high rates of inflation and rising interest rates.’

‘Uncertainty persists for the wider real estate market in the form of challenging debt conditions, lack of clarity around ESG (environmental, social and governance) factors, including the implementation of EPC targets and structural changes impacting certain sectors, in particular offices.’

Yet there are green shoots emerging, says Ardalan, with UK inflation falling and interest rates approaching or at their terminal levels.

At an operational level, the firm is enjoying robust rental growth, 100% occupancy and 100% rent collection with 98% of rents benefitting from inflation-linked or fixed rental uplifts.

‘Our tenant covenants have been enhanced by strong trading results and the embedded rental uplifts from our long leases are providing ongoing rental growth. At current valuation levels, many of our properties are held significantly below their reinstatement/construction cost, providing a material underpin to long-term capital and rental growth prospects.’

And there are signs the decline in total returns may have run its course, with real estates services outfit CBRE reporting capital values across UK commercial property fell by 0.4% in September while rental values rose by 0.4% meaning total returns were flat for the month but up 0.3% for  the quarter.

PROPERTY MARKET ACTIVITY PICKING UP

One of the big issues for property valuers and investors alike has been the dearth of transactions, which makes it had to get a handle on capital values, but several firms have recently announced asset sales in line with or ahead of their latest valuations which is encouraging.

At the beginning of the summer, UK Commercial Property REIT (UKCM), which manages a £1.3 billion portfolio, announced it had sold a logistics site in Wembley for £74 million, in line with its March 2023 valuation.

In its half-year update in September, the firm reported occupancy of more than 96% after it successfully let 107,000 square feet of EPC A-rated industrial space at its Sussex Junction site, just off the A23 at Bolney, and manager Will Fulton noted an uptick in sentiment in the logistics sector ‘with pricing and performance demonstrating tentative signs of stabilisation’.

In early October, AEW UK REIT (AEWU) announced it had sold a freehold high-street retail holding in Portsmouth for £3.9 million representing a 22% premium to its June 2023 valuation.

Portfolio manager Laura Elkin said the team was ‘pleased to have sold this holding for a healthy premium to valuation, having completed the asset management strategy and therefore maximised value’.

On 10 October Warehouse REIT (WHR) reported it had sold two assets, one in Cardiff and one on the Isle of Wight, for a total of £9.5 million, 30% ahead of their March 2023 book value, bringing total sales since the start of April 2023 to £39.6 million and £94.3 million over the last 12 months.

‘The premium to book value achieved across these sales provides further evidence that liquidity for well-let warehouse assets remains and illustrates the company’s ability to create and crystalise value for shareholders through asset management despite the difficult macro-economic conditions,’ said Simon Hope, co-manager of Tilstone, the firm’s investment advisor.

THE APPEAL OF ‘LONG INCOME’

For investors who like the look of commercial property but do not want exposure to the ups and downs of the economy, ‘long-income’ sectors like primary care facilities, care homes and student accommodation are a potential solution.

In its first-half trading update last week, Assura (AGR), the largest primary care investor and developer in the UK with a portfolio of 612 properties, said it continued to see ‘growing and consistent demand for high-quality healthcare buildings in a community setting’.

The firm settled over 150 rent reviews with a strong uplift, while it continued to grow its portfolio, completing a state-of-the-art day case hospital in Kettering, moving on site with an ambulance hub for the local NHS trust in Bury St Edmunds and acquiring another asset in Ireland where it is expanding its operations.

Target Healthcare REIT (THRL), the FTSE 250 trust which invests in modern care homes, announced its full-year results last week showing an 18.8% increase in earnings per share thanks to what it called a ‘robust and resilient portfolio performance’.

Like-for-like rental income grew 3.8%, predominantly driven by reviews, while rent collection was 99% for the quarter to September, ahead of pre-pandemic levels.

The company sees ‘compelling sector tailwinds with long-term demand from an ageing population supporting both investor and operator activity in the sector’ while at the same time there is a chronic lack of modern, fit-for-purpose care home accommodation.

BIG DEMAND FOR STUDENT ACCOMMODATION

Meanwhile, Unite Group (UTG), the UK’s leading owner, manager and developer of student accommodation, reported full occupancy, strong rental growth and stable property values for the three months to September.

Occupancy for the 2023/24 academic year is 99.7%, while average rents are up 7.3% reflecting the appeal of the group’s properties and its fixed-price, all-inclusive offer.

‘The UK is increasingly short of suitable student accommodation as HMO (house in multiple occupation) landlords continue to leave the market at pace. As the leading purpose-built student accommodation provider, we have a crucial role to play and we continue to work closely with universities to ensure students have access to high quality, affordable accommodation’, said chief executive Richard Smith.

Jefferies analyst Mike Prew commented: ‘The strong letting performance increases our confidence in delivering at least 5% rental growth for the 2024/25 sales cycle and supports our property valuations as the market adjusts to an environment of higher interest rates.’

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