Just when you thought it was safe to go back in the water…

“Just when you thought it was safe to go back in the water…” The oft-used quote from Jaws pretty much sums up investor confidence – or lack thereof – in the hugely unpredictable capital markets at the moment.

With so-called black swan events seemingly annual occurrences of late, the latest developments in the Midde East have again unsettled investors still reeling from the explosive correction in borrowing costs and post-pandemic structural shifts in some markets. Ongoing concerns about inflation reigniting in the event of a wider escalation of the conflict have punished REIT share prices yet again.

Yet, this may actually be an opportune time for investors to re-evaluate the sector as underlying fundamentals are, perhaps, more resilient than the market currently gives credit for.

November is always a busy month for UK REITs, with many reporting interim results or trading updates that will provide new data and narrative with which investors can reassess the sector. In our view, some of this generic data is already out there with available stats from MSCI confirming a lot of what many commentators already suspect.

Industrial and logistics asset valuations have stabilised and actually returned to growth over recent months, as have valuations of purpose-built residential and student accommodation. The logistics and industrial space remains structurally well positioned, with low vacancy and occupier demand continuing to outstrip forward supply. The sector has also seen a resurgence in deal activity, with some assets changing hands well above March 2023 valuations. These transactions help validate forecasts for net tangible assets and with stocks such as SEGRO, Tritax Big Box REIT and LondonMetric Property currently trading on 25-30% discounts to these forecasts, we believed there is good value to be had.

Retail valuations have also proved more stable, as a function of structurally higher yields having already been rebased and growing transactional market activity in both retail parks and shopping centres. While the collapse of Wilko made recent headlines, retail property continues to benefit from the growing dominance of omnichannel operator models (including M&S, Next, Boots etc), while pure-play online operators have struggled post-pandemic. With positive real wage growth underpinning consumer spending, retail parks remain in strong demand for investors (given the there are no longer any new ones being built), while interest in shopping centres is also rumoured to be growing – British Land, Landsec and NewRiver REIT look well placed in this regard.

Offices, however, remain largely in a world of pain. The prime elements of core West End offices are performing well and take-up of space increased from 520,000 sq ft in Q2 2023 to 746,000 sq ft in Q3 while vacancy of just below 6% remains well below the long-term average.

However, the picture is less rosy in Canary Wharf and regional UK cities, where increased hybrid working has led to reduced space take-up and vacancy rates are running way above long-term averages. With yields here moving further outward, valuations for most offices have continued to slide in 2023.

The game-changer though is development, particularly in central London, which is helping to separate the best from the rest. Aspirational, well located and sustainable buildings that can embrace the changing the role of the office for occupiers wanting more flexibility with their space needs should outperform. Delivery of such assets by Derwent London and GPE over the next few years into a supply-constrained market should help drive upside to net tangible asset values and provides future attraction to the current deeply-discounted investment cases.