Turkey of the week: property fundamentals still awful
By
Paul Hill Aug 07, 2009
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Back in January 2007, the share price of Land Securities, Britain's largest real-estate investment trust (Reit), reached a record high above £21. Since then it has dived as commercial property values have fallen 44%, driven by bank deleveraging, distressed sales and weak demand.
But isn't now the time to get back in? The bulls reckon we're about to see values of retail and office premises surge as the recovery takes hold. Even Land Securities' CEO Francis Salway recently declared the bloodbath over and said prices would, at worst, fall another 5%.
This is wishful thinking. Some speculative money may be returning to the party, but the fundamentals are still awful. As unemployment rises above 10%, there'll be less need for office space.
Worse still, families will have less in their pockets, leading to more high-street casualties, such as Allied Carpets and MFI. Shop vacancy rates have already hit 12% from 4% in mid-2008, reports research firm Local Data, and the British Retail Consortium chipped in last week, saying that "15% of shops will be empty by the end of 2009".
Land Securities (LSE: LAND), rated a BUY by KBC Peel Hunt
How can commercial property recover under these conditions? There may be a respite as vulture funds snap up key assets on the cheap, but without a sustained pick-up in GDP prices will go on falling. There's also an estimated £78bn in commercial mortgages due for refinancing between 2011 and 2012. If they're hard to roll over, it could trigger another wave of distressed sellers, flooding the market.
Landlords are staring down the barrel of future tenant renegotiations, because if a lease was agreed in 2004 or after, it's more than likely that the rent is way above market value. Lastly, London business rates are set to rise in the autumn by as much at 90%, potentially pushing many of Land Securities' clients into the hands of the receiver. I reckon commercial property values will fall another 15%, giving a 60% peak-to-trough fall. So what's the upshot for Land Securities?
In March the firm owned a £7.9bn property portfolio (mainly UK retail parks and London offices), giving an average 7.3% yield and secured against £4.5bn of net debt – all told, equivalent to a net asset value (NAV) of 593p a share. Assuming an extra 15% fall and compounded by the negative effect of gearing, this would drop below 450p a share. I would rate the shares on a 10% discount to NAV, which in turn delivers an intrinsic worth of about 405p a share – or around 30% less than today.
Recommendation: AVOID at 579p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments
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