The UK Real Estate Investment Trust (REIT) sector is on the cusp of a major re-rating, according to Matt Norris, Investment Adviser to the VT Gravis UK Listed Property Fund.
“A combination of six favourable economic and market dynamics mean that the sector could be poised for substantial growth in the coming months,” Matt commented. “It’s an optimal environment for a long-overdue re-rating.”
Six key drivers
Six factors have converged to create a much more positive environment for UK REITs.
1. Base rate cuts: The recent base rate cut, with the potential for further reductions before the year-end, should lower future refinancing costs and reduce the discount rates used to value properties. Valuation yields have also plateaued. “This creates a favourable financial backdrop for REITs, enhancing their appeal to investors,” said Matt.
2. Growing economy: The UK economy is also demonstrating resilience, with a soft landing evident in recent economic data. “Q2 2024 GDP grew by 0.6%, inflation is finally nearing the 2% target, and unemployment remains low at 4.2%,” Matt continued. “These indicators suggest a stable and growing economic environment, which bodes well for the real estate sector.”
3. Property values stabilising: “After a period of uncertainty, there are clear signs that property values are stabilising,” said Matt. “Valuers have become more optimistic, particularly in mega-trend sub-sectors where property valuations appear to have bottomed out. This stabilisation is crucial for restoring investor confidence and driving a re-rating.”
4. Limited new supply: “The supply of new developments is constrained due to the inability of merchant developers to finance speculative projects at previously high interest rates,” explained Matt. “Additionally, risk-averse management teams are increasingly requiring pre-let agreements before embarking on new builds. I expect this limited supply, coupled with sustained demand, to support rental growth.”
5. Growing rents: Elaborating on the last point, Matt continued: “Rent growth is being driven by a combination of mild inflation, economic growth, and the constrained supply of new properties. For highly desirable, modern, purpose-built, next-generation real estate, this dynamic is resulting in notable rental increases.”
6. Historically wide valuations: “Despite these favourable conditions, UK REITs continue to trade at historically wide valuation discounts,” continued Matt, “presenting a compelling opportunity for investors.” UK Real Estate Investment Trusts (REITs) have been trading at a wide discount to net asset value (NAV) for some time: around -20% vs the 10-year average of -15.9%*.
“After a difficult period for the asset class, things are looking up,” concluded Matt. “The interest rate easing cycle has begun, credit spreads – the difference between the rate at which REITs can borrow and the central bank rate – have shrunk, valuation yields have plateaued, and rents are growing, so values should climb higher as new supply will take some time to come in. This is all good news for REIT investors.
“I believe we are at a pivotal moment for the asset class, with all the ingredients in place for a significant re-rating and a strong foundation for future growth. As the sector continues to trade at attractive valuation discounts, investors have a unique opportunity to capitalize on the potential upside in the months ahead.”
