The demise of the REITs

I recently posted on LinkedIn some comments relating to “Another listed REIT bites the dust”. I was of course referring to the future absorption of SEGRO by Prologis, the largest listed US REIT.

Yes, the price was attractive, but not mind boggling and we will look back in a few years’ time and state: “That was cheap. How on earth did that happen?”

It appears to me that in most instances, management do not really have “skin in the game”. The exception is David Sleath who was not an owner, but did act like one. They might put up a bit of a fight initially, but many non-executive directors (NEDs) have little or no shareholding and probably do not want to rock the boat. I am particularly critical of these serial NEDs many of whom have never created businesses, so have never been on the frontline and had to worry about things like payroll.

In 2005, I was a NED of a public property company, when the major shareholder, who was looking to sell, advised the board that he had effectively agreed the price for the company with another listed property company as he considered it very attractive. He asked us would we endorse it. To his utter amazement, we told him that the price was too low. We knew why the bidder was interested and that our adviser should go back with an indication as to what we would accept, which was 10% more; they paid just under that.

We had done our job and protected our reputations in making sure external shareholders got an excellent deal. Are we seeing much of that today or are boards succumbing to good offers, but not great ones, and are they ignoring the future potential of the company? SEGRO has huge potential, but shareholders are only receiving 9% above NAV, with nothing factored in for future growth and Prologis make a very significant stamp duty saving on the shares element.

On a smaller scale, Picton is about to disappear being taken over by LondonMetric and Schroder REIT. Why is this happening and is there any future for listed property companies on the London Stock Exchange, with competition coming not only from the US, but Europe and Asia as well?

One of the issues is whether the people running these companies have “skin in the game” as mentioned above. Most of them do not, but look at LondonMetric where Andrew Jones does. He is a class act, LondonMetric istrading very close close to NTA, they have acquired Mucklow, CT Property Trust, Urban Logistics, LXI and Highcroft Investments predominantly for shares and are about to do the same with part of Picton albeit at a slight discount. He is using the London Stock Exchange to maximum advantage. Each day must be like Christmas to him.

Home REIT which has turned out to be an unmitigated disaster for shareholders is a case of how not to do it. Appointing an external manager is never in the shareholders interest, as they generally hold very few shares, but have a lucrative management contract. The model here was quite ridiculous, as it was left to the manager to acquire the properties, whilst the board were all NEDs with little or no property experience and very few shares.

I make these comments having experienced life as co-founder and CEO of Palace Capital, which is still listed as a REIT, but is a shadow of its former self. My partners and I acquired control of what was effectively a shell in 2010, as we saw an opportunity in the regional market. We acquired a regional portfolio in 2013 from Quintain effectively for £40m We needed to raise £23.5m of equity at 200p per share. We would not have raised £50 if Stanley Davis, my co-founder and chairman, had not seeded it with £3m of his own money. As CEO, I also had to make a significant contribution and even Richard Starr, who was our agent on this deal, made an investment and joined the board.

With all the talk of only being a £25m company after the fundraise, why were institutions and others willing to invest in us? They were confident with our financial commitment and board composition. We raised a further £20m one year later at 310p and the following year, a further £20m at 360p. This was to acquire a further portfolio of £32m and a leisure scheme for £20.7m.

I recall that our investors were never concerned with market cap or scale. We were active, so there was enough liquidity in our shares.

However, as time went on with Brexit, Covid, etc, I started to notice that instead of focusing on making money, we were constantly reminded of corporate governance, compliance, ESG, human resources, etc. This is why annual reports are so long that nobody wants to read them. Why float and put up with this when private capital is available on an increasing scale?

In earlier years, the great characters of our industry like Michael Slade, Nick Leslau and John Burns to name but a few, did not have to worry about all this. They could focus on making money and delivering stellar returns for their shareholders, which they did.

Now, we have activists who are rarely concerned for the company, but focus purely on financial engineering, like share buybacks or selling all the assets and returning the monies to shareholders. Both rarely work, but some boards still fall for it. Are some NEDs not up to it and not prepared with the management team to fight their corner? Are property owners worrying about listing in case activists come on board and ruin the party, or getting bogged down in regulation?

Look at Saba, who made a great play for the Workspace Group and are biding their time having failed to secure their initial objective. They have taken stakes in Grainger, Derwent and Unite Group, who are all trading at significant discounts to their NTA. These companies will need to perform, otherwise they will be history within the listed sector.

Activists did come on board at my former company, Palace Capital, but most shareholders backed them and not the management team. So, what happened? The shares are now less than they were from our first fundraise in 2013 – a lesson to be learned.

So, is there a future for UK REITs? My answer is yes, in that the great advantages are firstly, one can buy corporately using shares as currency instead of cash, secondly, you can save considerable SDLT, and finally, on an acquisition wipe out any inherent gains within a target company.

The best advice I got just before I left Palace was from a seasoned veteran who told me that we had the wrong shareholders who focused on the wrong issues. Go out of your way to recruit NEDs who whilst concerned with governance know that the priority is the total return to shareholders, however it is done. His company was not much larger than ours, but he never had to worry about scale or liquidity, because his shareholders only followed the money. They still trade close to NTA.

This is why I believe that there is a gap in the market for a REIT that is focused on total return. I might even have a go myself; I have done it before on more than one occasion, so maybe I will do it again! There will be significant opportunities before this rabble leave office.