Commercial property price falls allow healthy companies to boost portfolios

Land Securities - Matthew Lloyd/2015 Bloomberg Finance
Land Securities - Matthew Lloyd/2015 Bloomberg Finance

The outlook for Britain’s commercial property market has rapidly deteriorated over recent months. Swift interest rate rises and downbeat economic forecasts have combined to prompt a widespread decline in commercial property prices that is set to persist over the short run.

While this may seem like a disaster for companies operating in the sector, such as this column’s previous real estate investment trust (REIT) tip Land Securities, it also presents an opportunity.

Companies with solid financial positions can take advantage of falling asset prices to boost the size, breadth and quality of their portfolios in order to capitalise on a long-term commercial property market recovery.

Indeed, Land Securities’ recent disposal of prime office space in London for a total consideration of around £350m further boosts its financial standing.

It plans to use the proceeds from the sale to reduce debt so that its loan-to-value (LTV) ratio stands at less than 29pc, which is towards the lower end of its 25 to 40pc target.

And with an average debt maturity of just under a decade, as well as no need to refinance any existing borrowings for three years, the trust is in a strong position to ride out, and potentially exploit, current economic difficulties.

Its latest asset sale forms part of an overall strategy devised in 2020 that is vastly reducing its exposure to mature, low-yielding London offices. The plan has prompted £2.1bn in property sales at an average yield of 4.4pc, with £400m in additional sales yet to be delivered, as the company seeks to pivot towards office space that has a yield on cost in excess of 7pc.

It also plans to invest heavily in urban mixed-use developments that offer significant flexibility in terms of cost and delivery timeframes. This is likely to prove highly useful given the uncertain economic backdrop.

Of course, demand for Land Securities’ existing portfolio of properties is likely to come under pressure in the coming months.

A recession, if it takes place, will curb demand for offices that comprise 74pc of the company’s portfolio, while tough operating conditions for consumer-focused businesses are likely to lower demand for the trust’s retail locations that make up 18pc of its portfolio.

This could lead to a slowing rate of rental growth, lower occupancy levels and higher default rates.

However, the company’s portfolio consists of high-quality assets that are likely to perform relatively well in an economic downturn. Its office properties, for example, are energy efficient, well located and recently developed in desirable areas that are likely to experience robust demand even during a period of economic decline.

Similarly, its retail assets are situated in prime shopping centres and outlets that are less likely to be vacated by major brands who are seeking to rationalise their portfolios as online retailing grows in popularity.

Furthermore, investors appear to have fully accounted for a challenging period across the commercial property sector by demanding a wide discount to the company’s net asset value. Land Securities currently trades on a price-to-book ratio of around 0.7. While its net assets per share declined by 4.4pc in the first half of the year, and are likely to fall further in the near term, Questor views the stock’s current market value as being significantly below its intrinsic value.

Since first being tipped by this column in June 2018, the stock’s price has fallen by around 23pc. This represents a hugely disappointing return when the FTSE 100 has gained 3pc over the same period on its way to a new record high.

However, with dividends paid by the company since being tipped equating to roughly 18pc of the original purchase price, the stock’s total return is far less dispiriting than its capital return. And with a dividend yield of 5.2pc, its long-term income prospects remain sound.

Undoubtedly, Land Securities faces a tough near-term outlook as further interest rate rises are likely to weigh on the commercial property sector. But with a solid financial position relative to its peers, a high-quality portfolio and the capacity to use the market cycle to its advantage, it remains an attractive long-term investment while it trades at a substantial discount to net asset value. Keep buying.

Questor says: buy
Ticker: LAND
Share price at close: 719.2p

Read the latest Questor column on telegraph.co.uk every Sunday, Tuesday, Wednesday, Thursday and Friday from 6am.

Read Questor’s rules of investment before you follow our tips