A Delicate Balance

Real estate investment trusts (REITs) have become very attractive recently, as they offer an attractive yield, but, with a healthy yield comes some unhealthy risk. As illustrated by retail property focused companies.

The structural shift impacting retail is well documented, with the rise of online shopping, which now accounts for almost 20% of retail spend, and the decline of traditional high-street shopping.

The effect on rental income for retail landlords has been monumental and has led to huge write-offs in property values, leaving many trading at significant discounts to net asset value (NAV).

However, the fall in property values and share prices of retail-focused companies are reaching a level that makes the sector attractive again for opportunistic investors.

It was certainly the case for South Africa's largest REIT, Growthpoint Properties, which bought a majority stake in Capital & Regional last month and plans to grow the company with an £78m injection of cash.

Capital & Regional's share price, which had fallen 173% in three years, was a key reason the deal was made, but more important was Growthpoint's belief in the UK shopping centre sector - especially the community-focused malls that Capital & Regional work with - and the management team behind it.

It’s hard not to get distracted by all the negative headlines surrounding retailer failings. However, there are areas of the retail property sector that are emerging as potential areas for growth.

Growthpoint believes there are opportunities in community-focused shopping centres, on the premise that tenants of these malls are less impacted by online sales.

Retail parks is another sub-sector that has an interesting demand dynamic. The rise of e-commerce has led to a rise in click-and-collect services due to free deliveries, failed deliveries and returns eating into the retailer's profits.

To provide a top click-and-collect service the retailer needs space on a retail park. They are generally located on the edge of town centres with free parking.

Retail parks also often provide bigger and more efficient space at lower rents to high-street or shopping centre stores.

Next is one of many retailers shutting high street stores and opening in retail parks - specifically for the click-and-collect service.

Data suggests that almost 40% of customers bought an additional item in-store while collecting their order.

The NewRiver REIT, which is trading at a 26% discount and offering a 12% yield (one of the highest in the sector), has embarked on a strategy of buying regionally dominant retail parks for this very reason.

It hopes to capture rental growth from the increased demand from retailers for these kind of stores. It’s buying the retail parks at attractive yields of around 9%, taking advantage of the price dislocation in the market.

While the retail property sector has suffered due to the structural shift in consumer spending, the industrial sector has certainly benefitted over the past five years as the growth in online sales boosted demand for warehouse space, which in turn has boosted rental growth and property values.

The sustained growth has led many to question how much longer it can sustain its outperformance.

There are pockets of growth still to be had, however, especially in the urban logistics sub-sector, which is experiencing huge demand from retailers looking to service the 'last-mile' of the supply chain from warehouse to front door.

There are some interesting players operating in this field - Urban Logistics REIT being one (9.1% discount with a 5.3% yield) - that are not only benefitting from a surge in demand but also a shrinking supply of these types of properties, usually in the 20,000 to 200,000sq ft size bracket.

European logistics is another area that is expected to produce great returns over the next few years. Penetration of online sales in Europe has lagged behind the UK, but is on a similar growth trajectory to that witnessed in the UK five or so years ago.

Both Aberdeen Standard European Logistics Income and Tritax Eurobox (both trading at slight discount to NAV and offering 5.2% and 3.2% yield, respectively) expect to benefit from significant rental and capital growth as Europe plays catch up.

The companies can acquire assets at comparatively better value than their UK counterparts, and when significantly better financing costs in Europe are considered, the yield spread appears favourable for European assets.

https://www.investmentweek.co.uk/opinion/4007439/balancing-yield-risk-property-sector

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