Is there a future for real estate small caps?

In the past few weeks, there have been a number of announcements regarding further consolidation in the listed real estate sector. LondonMetric and LXI, Custodian REIT and Aberdeen Property Income Trust, Tritax Big Box and UK Commercial Property have all merged and now Urban Logistics and Aberdeen Property Income Trust are gatecrashing the party. Remember these are all share exchange deals, so there is no cash involved.

This is all not surprising to me as when I was CEO of Palace Capital, potential consolidation was always high on the board’s agenda, particularly in my last two years. We had discussions with various parties, but either the other side were not interested or we could not recommend a deal to shareholders, particularly where there was no cash involved. I have no regrets in this regard and have been proved right.

Does this all mean that unless you have a market cap of at least £500m, there is no point in being listed and that you should therefore consider a sale of the assets, returning the proceeds to shareholders, or look to be taken over on the best terms possible. I do not believe so. Although it might have worked with Circle Property, which had a small market cap, they sold most of their properties prior to the significant downturn. I look at Picton Property Income and AEW UK REIT and to me, they are success stories.

In 1998, Brown Cooper Marples, now known as BCM Real Estate published the ‘Quoted Property Company Market Report’. A number of companies are around today that were in that report. At that time, Land Securities (now Landsec) had a market cap of £5.05bn, while today it is even less at £4.8bn. British Land was at £3.1bn and is now only £3.4bn.

If we look at three other companies, what do we see: Workspace had a market cap of £60m and is now at £978m; PHP was at £14.9m and is now £1.2bn; and St Modwen had a market cap of £85.3m and was sold to Blackstone for £1.3bn in 2021.

There has also been some disillusionment with the London Stock Exchange not only with increasing talk of companies moving their listing to another jurisdiction but also with some UK investors who are not only short term in their thinking but also appear to focus on directors’ salaries and excessive corporate governance. This is not what happens in the US. If they are performing, let them get on with the job.

Just before I resigned as CEO of Palace Capital, an article appeared in the Sunday Times suggesting that some shareholders were unhappy with the returns they had been receiving. In 2017, after consulting with some shareholders, we took the bold but sound decision to develop a two-acre site that we owned very close to York Station. We built 127 apartments and 35,000 sq ft of offices. We completed the scheme in April 2021, despite Covid taking effect in March 2020. By the end of our financial year, which was 31 March 2022, we had sold and completed on 80 apartments, let 75% of the office space and paid off Barclays Bank. The stellar returns were on their way as we had also sold 14 other buildings at 20% above book value, so why the short-term thinking? You can understand why smaller companies can get frustrated.

My good friend, Stanley Davis and I recently acquired a significant stake and board control of a cash shell known as More Acquisitions plc listed on the Main Market. Through his pension fund and in a private capacity, another good friend Andrew Perloff also acquired a similar stake to ours that he has now increased. We were the three original founders of Palace Capital in 2010. Andrew is chairman of Panther Securities plc, which is listed on AIM and he acquired control of in 1972. Panther has a market cap of only £51m, but it has generated stellar returns for shareholders. I go to his AGM every year and his loyal band of shareholders love him. They do not care what his market cap is, only the returns.

We believe that market conditions are not dissimilar to when we founded Palace Capital, after which we were able to acquire companies with tax losses, unclaimed capital allowances and of course savings in Stamp Duty Land Tax. We saved over £11m with the latter.

The opportunities are now appearing and all it needs is a slight change in sentiment towards the listed real estate sector. Leading commentators will probably agree with me that in an economic recovery, the small to mid-caps outperform the larger. All it needs is for investors to recognise this fact and follow those that produce the returns. Yes, there might be a liquidity issue although at Palace this was rarely a problem, but if you are a medium- or long-term investor, size is irrelevant. Panther have shown us that in spades.