I. Sector landscape and outlook

Real Estate Investment Trust or REITs are the investment trusts which hold real estate assets under management and are often listed on the stock exchange. REITs are generally close-ended investment trusts, where one can become a member by acquiring units from the stocks exchange. It can be a single company REIT or a group REIT that owns and manages the property on behalf of shareholders. It enables owners of real estate to pool income-generating assets together in a portfolio and allows investors to buy ownership in real estate assets in the form of equity. It is created by a sponsor, who transfer the ownership of the assets from a special purpose vehicle (SPV) to a REIT in exchange for its units. The sponsor is obligated to hold certain units of REIT. British REITs have to distribute 90% of their income to investors.

Fig 1: Operating Model of REITs

Source: RBSA Advisors
 
REITs are universally accepted by global institutions and individual investors as a product that provides:
 

1. Liquidity

2. Transparency

3. Diversification

4. Dividends
 

UK REIT Sector

In the United Kingdom, the REIT regime was introduced in January 2007, which immediately saw a number of the UK’s largest listed property companies converting into REITs. Since then, the regime has continued to evolve, with a number of developments in recent years increasing the attractiveness and accessibility of the regime to a wider pool of property investors and providers of capital. REITs have provided a well-established method to structure collective investment in UK real estate and the ability for investors to efficiently access rental income streams from wide-ranging, underlying real estate assets.

There are over 50 REITs with a market capitalisation of over $70 bn listed on London Stock Exchange investing across industrial, office, residential, retail, speciality, hotel and lodging real estate.

Fig 2: REITs in UK


Source: London Stock Exchange.

Fig 3: Advantage of REITs


Source: Kalkine

Key requirements to maintain REIT status in the UK

1. Admitted to trading on a recognised stock exchange: The REIT must be admitted to trading on a recognised stock exchange. Further, it should be either listed on such an exchange or traded on such an exchange in every accounting period, except the first three years.

2. Distribution conditions: The REIT must distribute 90% or more of its tax-exempt income profits (not capital gains), as well as 100% of any property income distributions received from other UK REITs, by the filing date of the company’s tax return (usually twelve months after each accounting period end).

3. Property rental business conditions: The REIT must hold at least three properties. Of these, no single property can exceed 40% of the total value of the properties in the property rental business. For these purposes, properties that would be regarded as owner-occupied for accounting purposes in the REIT’s consolidated accounts do not count as property rental business properties.

4. Financing cost ratio: REITs are required to maintain a profit-financing cost ratio of greater than 1.25:1; otherwise a tax penalty may arise.

5. Balance of business condition: At least 75% of the REIT’s gross assets and at least 75% of the REIT’s accounting profits, on an IFRS accounting basis, must relate to the property rental business.
 

COVID-19 Pandemic Impact on the UK REIT Sector

Much has been spoken about the difficulties and opportunities has come out because of market swings emerged on account of COVID-19 pandemic, but the impact stretches far beyond the stock falls of March. The COVID-19 pandemic and the subsequent widespread public lockdown would undoubtedly have far-reaching and more long-lasting structural effects on society.

However, Britain’s REITs sector trends that were already in motion prior to the 2020 COVID-19 outbreak have only accelerated, and this has proven particularly beneficial for REITs in the logistics sub-sector, which has largely outperformed other REIT sub-sectors in recent years. With restrictions on how often people can leave their home, online shopping has understandably boomed. In April, ONS data estimated monthly growth was at 15.8% for online retailers, and online sales market share spiked to 30.7% of retail sales. The magnitude of this sudden shift should not be underestimated. This explosion in e-commerce is one of the biggest drivers pushing the outperformance of logistics REITs. CBRE research estimates that warehouse-based e-retailers require 2.5 times the square footage of logistics space compared to traditional retailers. Clearly, a greater volume of online orders naturally increases the demand for logistics space for the stocking, picking, packing, and shipping of products direct to shoppers’ front doors. CBRE estimates that every extra £1bn of online sales requires an additional 868,000 square foot of space.

Fig 4: YTD Performance of the UK REIT Sector (on August 10^th, after the market close)

Source: Kalkine, Refinitiv (Thomson Reuters)

Why one should invest in the REIT stocks?

Long term growth prospect:The Coronavirus pandemic has dealt a significant blow to the global REITs market as the outbreak of the virus has directly reduced the demand for people to rent places for different purposes and the average return of REITs on a YTD basis is negative (-18.7%). However, we believe that the negative impacts will only last for a short period on REITs. In 2006, REIT was the top-performing asset class. During the financial crisis in 2007 and 2008, closures of businesses and mass-scale job loss had led to the decline in the REITs market. As economic activities began to recover in 2009, REITs obtained a very strong rebound and subsequently became the top-performing for 3 consecutive years since 2010. As the global economy is showing signs of sustainable economic recovery, we believe that REITs would gradually deliver its consistent performance and be a beneficiary of the global economic recovery.

1.9x of the Dividend Yield Compared to the FTSE 250:At the current price level, the UK REIT stocks are offering a lucrative average dividend yield of 4.8%, which is approximately 1.9x of the FTSE 250 index average dividend yield of 2.6% and approximately 1.25x of the FTSE 100 dividend yield of 3.86%. This offers a lucrative entry point for the investors to benefit from the higher dividend yield amid times when the interest rates are falling globally, and opportunity costs of fixed income securities investing are fading. Further, REITs offer access to the real estate market typically with low correlation with other stocks and bonds. As an income alternative to cash, term deposits and bonds, REITs are valued for their consistent distributions which are predominantly derived from the rental income earned on the trust’s properties. With the income coming from fixed, generally long-term rental contracts, the distributions are generally more predictable and stable than dividends payable from a listed company.

Risk Associated to the Sector:The second wave of COVID-19 outbreak and a potential slowdown in the British economy, jobs cuts and shrink in the business activities can hit hard Office REITs, Residential REITs, Retail REITs as compared to Diversified REITs, Health Care REITs, and Industrial REITs. Further, uncertainties surrounding over the soft Brexit is posing another risk of the UK REIT sector.
 
II. Investment theme and stocks under discussion (BYG, DIGS, PCTN and BLND)

After understanding the recent trends in the industry, let’s now look at the four players from the industry those are listed on the London Stock Exchange. To assess the same, companies’ stocks are evaluated based on EV to EBITDA.