One of the property industry’s leading commentators has called the top of the market, predicting the value of the UK’s real estate investment trusts (REITs) will stall in the first half of next year and fall in the second half of 2016.


Mike Prew

The prediction has been followed by major falls in the shares of some of the nation’s largest property companies this morning as stock markets across the globe were hammered by growing concerns about the future of the Chinese economy.

Mike Prew, an equity analyst with Jefferies International, said he expected commercial property values to deflate in 2016. In a note published this morning Prew said: “With rising cap rates and patchy rental growth driven by retail so REIT shares will de-rate. The bear case is compounded by proposals to limit the tax shield on debt to 30% of EBITDA.”

Prew downgraded some of the UK’s biggest property groups including British Land, Hammerson, Intu, Unite and Capital& Counties (CapCo).

Following Prew’s note, shares in all five companies fell: British Land by 3%, CapCo by 4.7%, Hammerson by 2.9%, Intu by 2%, and Unite by 3%. The FTSE 100 was also down 2% in early trading following falls across Asian stock markets.

In his note, Prew added: “Real estate values have adjusted to low rates to a point of equilibrium, which will be ‘punctuated’ when cash regains its value as rates rise. The bond tourists are going home and the real estate tourists are close behind, with property bidding hollowing-out.

“REITs have reverted from earnings vehicles to capital plays, and are still too indebted. Fresh money isn’t going into UK REITs, which yield less than equities (2.6% vs. 3.5%) with slow growth (3% v 4%).Cap rate contractions are over except in ‘Britzerland’ where they are moderating, and we expect them to decompress +30bps, which should be recognised by estate agents in 2016. Rental growth is patchy and we forecast the capital benchmark index to fall -1.1% (v. +5%) in FY16 (retail -4.4%; offices +2.3%, industrials -0.4%).”

Prew also pointed to the legislative risk posed by moves by The Organisation for Economic Co-operation and Development (OECD) as it drives through a series of financial reforms, which includes capping the tax shield on debt to a fixed ratio (interest/EBITDA) of 30% or maybe lower.

Prew said: “These are international and industry-wide proposals but particularly impacts real estate which is habitually highly leveraged. These will be presented to the G20 which may give the proposals legislative ‘bite’. If enacted this would be negative for real estate corporates, funds, unit trusts & PE. REIT earnings are struggling and whilst a tax shield limit makes no economic difference, they may have to pay out higher mandatory dividends leaving lower (or negative) retentions for maintenance CapEx and debt reduction.”

Prew downgraded British Land, Unite and CapCo from a buy to underperform, while Hammerson and Intu have gone from a hold to underperform. Meanwhile Prew has also downgraded Land Securities, Derwent London, Workspace, Big Yellow Group, Safestore, Grainger, and LondonMetric from a buy to hold. Prew only maintained his recommendation on Great Portland Estates, Hansteen, Shaftesbury, SEGRO and Uniball, all of which stay as holds for Jefferies.

“The UK REIT index has doubled over four years, but cap rates have fully adjusted to ultra low rates,” said Prew. “Last summer there was a new high water mark in asset pricing almost every week, but now trade is in equilibrium but that is set to be ‘punctuated’. Our models indcate that cap rates are overvalued by circa 30bps and the IPD All Property Capital Value benchmark will stall in the first half of 2016 and deflate in the second half. REITs have stopped performing with Land Securities and British Land recently hitting the price targets we set in October. That’ll do.”