Following on from last week’s column on the purchasing of property shares I finished by saying I would explain where to buy them. And so…
To summarise last week’s column, commercial property shares have had the most amazing pounding, but the turn of the market is not far away. Why? The Armageddon that everyone talked about where banks offloaded masses of commercial property has not materialised. Investors can now see sustainable yields from their commercial property investments and with savings rates as low as they are, yields of c 9% are difficult to ignore.
In this context we are talking about prime commercial assets as opposed to secondary. Secondary is almost unsellable. Prime assets are expected to bottom out from an underlying price point of view by the end of quarter three 2009, and the news that lenders are widening their loan to value supports that. Whereas many lenders were only offering 50-60% loan to value, this has eased off considerably as expectations of price falls have lowered.
Property shares normally react six to nine months earlier than the underlying asset so foresight is everything.
A real estate investment trust (REIT) is an excellent way to tap into this growth and make more than the actual asset growth itself. In 2007 REITs came into existence. The investment is a collective of property related investments which, in exchange for significant tax concessions, a company could convert to a REIT as long as it paid a 2% conversion tax, followed by generating at least 75% of its income from property rental, and distributing 90% of profit as a dividend.
So where is the opportunity for the investor? Consider with a REIT you are buying shares in a fund that invests in property shares. These underlying assets they are invested into will have a value. The share price of the overall REIT fluctuates wildly on the grounds of a number of factors but irrational exuberance and pessimism are two main contributors.
Hence the share price will trade at either a discount or premium to the value of the underlying assets. So if a share purchaser is very positive, the shares are in demand and are at a premium.
The last two years have been negative, capital values have been battered, and shares have been oversold. Most REITs are now trading at a considerable discount to the value of their underlying assets and therein lies the opportunity. For example Hammerson traded in February at a discount to its net asset value of an amazing 56%.(1) To explain what that means to you, if the total assets in Hammerson were realised they would be worth 127% more than the shares are currently valuing them at.
There lies a double opportunity to make excellent gains as sentiment returns so the discount will narrow. Even if the underlying assets don’t increase in price, you can gain from that discount to net asset value narrowing. Furthermore there have been a range of rights issues from REITs who clearly do not need the cash. Why would they do that? They have simply pulled together as much cash as they can to buy up distressed assets at the cheapest price possible. When the entire commercial property market (i.e. the assets in both prime and secondary) returns to favour, the upside return of this sector will be outstanding for those who bought well at the bottom. Buying well at the bottom however doesn’t mean buying when everything is reported by everybody as being perfectly in order. Making money with investments is about buying at the opposite point of that.
All that aside, consider that although property used to be classed as a balance to equities, REITs and property shares, despite what others say, are very closely correlated to equities – in other words you are closely correlated and not diversified.
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(1) investors chronicle
The value of shares and investments can go down as well as up