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UK commercial property trading at a discount

Commercial property is trading at a discount in London, suggesting investor pessimism.

Important: This is not a recommendation for you to buy or sell any shares or to invest in commercial property. I’m just a private investor, storing and sharing notes for wider interest. Please read my disclaimer.

A couple of years ago I made the case for buying commercial property listed on the UK stock market.

The various UK REITs1 had been hammered by big writedowns that downsized their net assets (NAVs). They looked vulnerable against the large loans they’d secured against those depreciating assets. Some had to raise extra cash via rights issues.

There were also fears that banks would dump property they acquired in the boom years (or been lumbered with after loans turned sour) as they desperately tried to shrink their own books.

Buying into this scenario might have seemed as appealing as elbowing past widows and orphans for last-minute tickets onto the Titanic. But there were reasons to be positive.

Rents for the better REITs had held up more than their plunging share prices suggested. Share prices had also fallen far below NAVs. At the bear market low you could buy £1 of Land Securities’ assets for as little as 36p!

Obviously, investors feared commercial property prices would fall further, taking NAVs with them. But as it turned out, the steep fall to 2001 levels in the prices of offices, warehouses and shops was enough to tempt in bargain hunters.

From 2009, commercial property prices firmed and then began rising, especially in the South East, and the REITS followed. (Some vulture funds set-up specifically to buy distressed property in London were complaining when prices bounced back too quickly!) It proved a great time to buy.

As well as traditional property players mopping up unfairly reviled assets, I suspect the QE operations began by central banks in early 2009 also helped stabilise the market.

Commercial property is an inflation-resistant asset, since both property values and rents should increase broadly in-line with general inflation. If you fear higher inflation down the tracks, it’s a good asset class to be in.

The idea is to buy cheap

Today REITs seem to have fallen out of favour again, perhaps due to fears over Europe. Well, that and the UK economy, which is now doing a good job of impersonating a hit-and-run driver reversing to make sure.

But I think the market is again being too pessimistic about commercial property.

Only a few years ago, investors couldn’t get enough of it, with new funds raising billions of pounds and helping to inflate a bubble that slashed yields and primed the crash to come. Price seemed irrelevant. Yet now commercial property looks pretty good value and the market seems to be taking a more balanced view of its prospects, the average investor doesn’t want to know!

That’s their loss. Commercial property is an attractive asset class to own, whether you’re a passive or an active investor, and I think now looks a good time to buy – not as cheap as in 2009, granted, but unless you expect a European blow-up not as risky, either.

The big players certainly haven’t capitulated; work on new skyscrapers in London is continuing apace. While I don’t think this expansion is due to any pressing shortage of floor space, I do think such confidence in the future of the UK capital is a handy wake-up call.

Commercial property for passive investors

Many passive portfolios include a substantial allocation to commercial property. David Swensen’s Ivy League portfolio suggests a big 20% holding, for example. Several other lazy portfolios have significant allocations.

Note that UK index trackers will give you some exposure to commercial property, since big REITs like British Land, Land Securities and Hammerson are all in the FTSE 100.

But the real estate sector is relatively tiny – less than 2% or so of the FTSE 100 – and dwarfed by basic resources, energy, banks and the like. Personally I’d add a specific property allocation to any passive portfolio, which I’d expect to dampen volatility and increase my income over time.

The iShares UK Property ETF (ticker IUKP) is an easy place to start. It’s yielding 3.1%.

(Note that very nearly 50% of that ETF is invested in the three largest REITs, which some may consider excessively risky, though it’s a fair reflection of the UK listed real estate market).

Active investing in property REITs

Those of us who undertake the dark practice of active investing should certainly consider the commercial property market at present.

  • If you tilt your portfolio towards income, the sector offers plenty of potential to grab higher yields for the long term.
  • Value investors might consider the discounts to NAV as attractive, though I don’t deny they could get a lot wider in the more dire scenarios.
  • If you have your own theme or pet view on where the economy is going, there may be a REIT for you. It’s easy to bet on London, for example. If you’re more optimistic about UK retail than most (I’m not!) then that’s another possibility.

UK commercial property trading at a discount

Here’s a summary of the ten largest companies in the UK real estate sector by market cap, price to book value (P to BV in the table), and forward yield.

Company Market Cap P to BV Yield
Land Securities £4.9bn 0.7 4.5%
British Land £4.1bn 0.8 5.7%
Hammerson £2.6bn 0.7 4.4%
Capital Shopping Centres £2.6bn 0.8 4.9%
Derwent London £1.6bn 1.0 1.9%
Segro £1.5bn 0.6 7.0%
Shaftesbury £1.2bn 1.1 2.4%
Capital & Counties £1.2bn 1.1 1.2%
Great Portland Estates £1.0bn 0.9 2.5%
London & Stamford £0.6bn 0.9 6.7%

(Data as of lunchtime on December 14th)

As you can see most commercial property companies are trading at a discount to their net assets again (prices went above net assets earlier in 2011) and there are tasty yields on offer. Companies on lower yields tend to be either owners of only prime London assets or more development-orientated companies, or both.

Please note you’ll want to check all these figures – and a lot more – before considering an investment. Various data services define net assets / book value in different ways, and forward yields also vary. Download the REIT’s latest annual results and do your own research.

While you’re at it you should also evaluate:

Debt: How much does the company owe, how heavily is it geared against assets, and how comfortably can it meet interest payments? When do loan to value covenants kick in? (They could trigger rights issues).

Rent: How much of the portfolio is let out? Is that number rising or falling? How bad did it get in the last slump?

Earnings and dividend: REITs must pay out most of their earnings as a dividend, so dividend cover is of little use here. Instead look at how earnings are growing, in conjunction with your rent research. How hard was the dividend cut last time?

Development: To what extent are upcoming developments pre-let? Does the company have the funding to complete its work? (Not a problem with big REITs, but a factor for smaller developers with money still tight).

Sector and geography: What are you buying into, and where is it? If you’re bullish on a bounce back in The City, you don’t want to buy a load of shops in the North.

Management: Subjective and difficult, perhaps the best thing to do is look back through management’s statements in the last downturn. Many key players have moved on, however.

Which UK commercial property companies look attractive?

Personally I like the look of the big two – British Land and Land Securities – which offer the chance to buy into incredibly diversified property portfolios at a discount and to hopefully secure a long-term growing income.

The most contrarian play is probably Segro, which focuses on industrial warehouses and the like. Not a happy sector, hence the high yield. Could be worth investigating if you sense the economy bottoming out.

The big London specialists such as Derwent London and Great Portland look pretty fully priced already. British Land and Land Securities have substantial London assets, too, albeit with plenty else besides.

London & Stamford is interesting. Veteran real estate moguls established the company just ahead of the slump, but they didn’t get a chance to deploy much of their funds before the recovery began. They’ve been very cautious about investing into the rising market, and have plenty of firepower left. Could be a good option if you’re cautious on the short-term but would like some professionals running your money. Great yield.

Price is the firmest foundation

None of the commercial property companies are going to thrive if the UK enters a deep recession or the Eurozone blows up.

I don’t think either is likely, and I’d argue the general gloomy sentiment makes it a good time to be hunting for bargains. I am not claiming prices will soar next month, or even next year.

Property has generally rewarded those who think long-term – provided they’ve bought into the sector at decent prices – so even if the immediate outlook isn’t great, I think valuation makes it a good time to consider investing.

In part two: A few ways to invest in small cap commercial property companies.

  1. Real Estate Investment Trusts []
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If you’ve got a portfolio full of index funds with Hargreaves Lansdown then you’re faced with a dilemma. Its platform fees knock back small investors like a thumbs down from Simon Cowell.

It’s a bitter pill that Hargreaves Lansdown have sugared with a sweet range of low-cost Vanguard index funds.

Is the price of staying with Hargreaves Lansdown worth the reward of the Vanguard funds?

Frankly, Hargreaves Lansdown is not the only place you can buy Vanguard. The sheer popularity of the funds has ensured their spread to other brokers, despite a slow start.

The terms vary from firm to firm but if cost is king then there are only a few scenarios where it makes sense to stay with Hargreaves Lansdown.

Your calculations may well be beset by the burdens of inertia, convoluted financial affairs, or a profound belief in Hargreaves Lansdown’s customer service, but for sanity’s sake I won’t grapple with any of that.

My main assumptions will be:

  • Cost is the trigger to switch platforms.
  • All Vanguard funds incur a £2 per month platform fee on Hargreaves Lansdown.
  • Hargreaves Lansdown portfolios only contain index funds costing £2 a month.
  • You stick with your broker for a minimum of one year.
When it's worth using Hargreaves Lansdown for Vanguard funds

The Vanguard runners and riders

When choosing your Vanguard platform, there are two main costs to look for:

1. The management charge for holding Vanguard funds – this may be known as an annual management charge (AMC), a custody fee, or a platform fee.

Whatever the name, it amounts to the same thing: a regular charge that covers the costs of servicing your account.

2. Dealing fees – a charge levied every time you buy or sell a fund.

Hargreaves Lansdown is the only broker that charges per index fund owned. Whether it’s worth you taking that on the chin boils down to YOUR:

  • Portfolio composition: You need to work out how many Vanguard funds you can hold before Hargreaves Lansdown’s pay-as-you-go fees cost more than the all-you-can-eat deals offered by rival platforms.
  • Trading habits: You need to figure out whether the waiving of dealing fees by Hargreaves Lansdown compensates you for its other costs, compared to the rival brokers.

The rival Vanguard-friendly platforms in the mix are Bestinvest, Sippdeal and Alliance Trust. You can find out more about their Vanguard costs here.

The short answer is that the fewer funds you own, the more likely it is that Hargreaves Lansdown will come up trumps. Hargreaves Lansdown’s deal gets even sweeter if you trade often. The type of account you want is important, too.

I’ve tried to make the summary below as simple as possible, but be warned it’s like comparing mobile phone deals.

Stocks and shares ISA: Is it worth staying with Hargreaves Lansdown?

Hargreaves Lansdown only wins for ISAs if your portfolio consists of a single fund.

In that case, the £24 platform fee undercuts all rival offerings and you can trade all you like.

Happily a diversified portfolio of one fund can be devised using Vanguard’s LifeStrategy funds.

Here’s the full range of ISA scenarios depending on the number of funds held in your portfolio:

1-2 funds = Hargreaves Lansdown
3+ funds / up to 8 x £1.50 regular trades = Alliance Trust
3+ funds / 8 or more trades of any type = Bestinvest

Note: Alliance Trust online regular investment purchases are £1.50 a throw. If you expect to sell even once (perhaps to rebalance) then Alliance Trust’s low AMC advantage is wiped out by its £12.50 dealing charge.

SIPP: Is it worth staying with Hargreaves Lansdown?

Hargreaves Lansdown does a bit better with its SIPP:

1-2 funds = Hargreaves Lansdown
3-4 funds = HL or Sippdeal. If you trade more than 2-4 times respectively then it’s HL.
5 fund / less than 7 trades = Sippdeal
5 funds / more than 7 trades = HL / Bestinvest dead-heat
6+ funds / more than 7 trades = Bestinvest

Note: Sippdeal charges £150 (plus VAT) to set up income drawdown and £75 (plus VAT) annually to administer income drawdown payments. Hargreaves Lansdown and Bestinvest charge nothing for the same.

Standard account: Is it worth staying put?

Scenario is currently the same as for ISA accounts.

Minimum investments

Bear in mind, your platform of choice may also depend on whether you can make the minimum investment contributions. On Vanguard funds these amount to:

  • Hargreaves Lansdown: £1,000 per fund, or £50 per fund in the regular savings plan.
  • Bestinvest: £100 per fund.
  • Alliance Trust: £50 per fund.

There’s a couple of other quirks, too. Hargreaves Lansdown charges 0.5% (plus VAT) per year on any ETFs, gilts or investment trusts you hold (capped at £45 or £200 in SIPPs).

Meanwhile, Alliance Trust wants £5 to reinvest dividends automatically (you can avoid this by using accumulation units or just reinvest divis yourself).

Strangest of all, Alliance Trust also charges £10 every time you want to withdraw cash. Does it also own those money-grabbing cashpoints in service stations?

Take it steady,

The Accumulator

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How we’ll die rich and irrelevant

Weekend reading

Ten years ago, Goldman Sachs’ Jim O’Neil brought the four big emerging economies to global attention by coining the term BRICs.

A decade later, and that’s what many in the West are now shitting as they imagine a future where Brazil, China, India and Russia set the international agenda.

It’s hard to remember how novel the BRICs concept was originally. Today you can’t turn on the BBC or read an article about investing without hearing about emerging markets and the growing Chinese middle class gorging itself on meat, Tiffany watches, and over-priced condominiums

Yet just ten years ago the private property market in China essentially didn’t exist! Memories of a botched coup and a financial crisis were still fresh in Russia, while Brazil was in investors’ minds still a banana republic. India was good at cricket.

Have we gone too far the other way? That’s a big topic, but one thing to understand is it’s demographics that underpins the most ambitious claims for the BRICs.

Yes, citizens in the BRICs getting richer, but we will, too. It’s just there’s billions more of them, so overall they’ll eat up more of the pie (on the menu: the world’s fast-diminishing natural resources and biosphere).

According to a new Goldman Sachs report timed to celebrate the anniversary of the BRIC concept, by 2050 the UK will still be the third richest country on a per capita basis out of the BRICS, the N-11 and the G71):

Our future: The world’s Uncle Monty from Withnail and I

Anyone reading (or writing) doom-laden missives about how BRIC growth will mean we’ll all be growing our own carrots and wearing the same hair shirt for 20 years needs to pay attention to this graph, and at least decide why they disagree.

The rise of the East (/South) does not point to poverty in the West (/North).

Crazy rich anglosphere

Don’t celebrate too much, though. While the gloomiest predictions of the fall of the West flounder on poor mathematics, very few are thinking about what it will be like to live in such a world.

Possibly only America will still retain today’s swagger on the global stage, and it could be a very different America to the one we know. Population growth will keep it in contention, and most of that will be Hispanic-speaking.

Will it have the same cultural values as 1950s America? For good or ill, unlikely.

As for Britain, to the average Chinese or Indian teen, we’ll be old fogeys who made history 1,000 years ago – rich and doddering towards the end of the pier.

Think of rich old Colonel Blimps turning out for the Trooping The Colour in London every summer.

Wealthy and with good stories to tell?

Sure. But no longer part of the future.

  1. Small countries like Norway, Singapore and the oil states will likely be richer on a per capita basis. []
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The future City of London skyline: New skyscrapers abound

“Such an exercise in architectural uniformity, however, could never succeed. London was too large to be dominated by any one style or standard. Of all cities it became the most parodic and the most eclectic, borrowing architectural motifs from a score of civilisations in order to emphasise its own position as the grandest and most formidable of them all.”

Peter Ackroyd, London: The biography

One thing that struck me when I went to see the St Paul’s protests a few weeks ago was all the building going on nearby. Like all good Londoners, I tend to ignore the apparatus of the mammoth conglomeration around me – i.e. most of the 607 square miles of London – preferring to focus instead on my own little travails, and the local cake shop that has started selling Lamingtons. It’s how you stay sane in a city of eight million people.

Walking around the City’s streets on a Sunday, however, with time to look up without being hit by a cab or an Australian on a mountain bike, the construction work is obvious. If capitalism is in crisis, then somebody has forgotten to tell the commercial property developers. They are investing in new London office space like hippies are going out of fashion.

True, some of the sites were mothballed after the 2008 downturn. But plenty have already been dusted off and restarted. Some schemes, like Heron Tower and the upcoming Shard, were never halted.

The result is that London is going to look quite different in five years time, as the digital artist’s impression in the little picture in the top right shows.

London is getting ready for the next boom

Reinvention and thumbing its nose at history is what London does – ironically for such a great historical City. Those who’d preserve every sight line to St. Pauls are trying to turn unplanned and sprawling London into something it’s not.

This is a mercantile mega-colony, thriving on trade, competition, and opportunity. Everything else comes after.

Now, I’m not suggesting there should be no rules or planning guides governing development. Nearly all of what has survived, from the little Wren churches dotted about the Square Mile to the Huguenot terraces of rejuvenated Spitalfields are testament to the importance of that.

But cities need to keeping moving, or like sharks they die. Go to Paris if you don’t believe me.

In some strange way, these new buildings rising across London convince me even more than rational analysis that the world isn’t ending, that the West is not dead, and that I should not swap all my shares for gold. The animal is alive, even if its spirits are still breathless and it’s acting on instinct.

Next week I’ll look at some specific ways to invest in London property. Many of the listed commercial property firms look good value again, after coming down from the post-2009 surge that (happily) followed when I last bought commercial property. Indeed some of the reasons for buying then still look good today.

First though let’s set the scene with an eyewitness tour of the property development going on right now.

Think capitalism is dead? Let me take you by the hand and lead you through the streets of London…

The Walbrook Building

Just a few minutes walk down Cannon Street, the new Walbrook Building (owned by Minerva) is offering nearly 400,000 square feet of space. Some say Walbrook Street was named after a stream that used to run through the City of London walls here. Like most London rivers, it was long ago buried underground.

Bloomberg Square

Far more depressing than skyscrapers – or even buried rivers – is the modern ability for corporates to rewrite place names in their image. Thus Walbrook Square (just over the road from the building above) is to become Bloomberg Square, after the media giant acquired the site for its new UK head office. The developer is unlisted Stanhope PLC.

20 Fenchurch Street

A few minutes walk further east brings us to 20 Fenchurch Street. This will eventually house the bulging 160m Walkie Talkie tower, the first of London’s big four new skyscrapers on our tour, and the one that most divides opinion, even among high-rise aficionados. Its developer, Land Securities, had planned to have the tower up by now, but the credit crunch squashed that timetable. It’s now due to be finished by 2015, though I didn’t see any evidence!

The Leadenhall Building

Anyone familiar with this part of London will find themselves drawn to the iconic Lloyds building on 1 Lime Street – still one of London’s most intriguing. The Leadenhall Building just across the road will at least physically put the Lloyds building in the shade, however. Better known to Londoners as The Cheese Grater, this 225m tower was designed by Richard Rogers. Work was halted by owner British Land in 2008, but it’s apparently restarted in conjunction with Oxford Properties. (Wikipedia claims 900,000 sq ft of office space, which makes me wonder if I’ve photographed the wrong corner!)

Heron Tower / 110 Bishopsgate

Here’s one they finished earlier. A short walk from Leadenhall Street, Heron Tower stands 230m tall if you count its mast, which makes it London’s third tallest building. To be honest, it’s not very exciting – people who complain about walkie talkies and cheese graters should come and see what sensible looks like.

The Pinnacle / Bishopsgate Tower / Helter-Skelter


Yep, it’s so far just more skips, cranes, and a snazzy font from the 1930s. But The Pinnacle looks set to be one of London’s most attractive super-buildings, with its swirling organic shape that you can see on its Wikipedia page. The building will be coated in solar panels, and like the nearby 30 St Mary Axe (aka The Gherkin) it will have a double-skinned layer to improve climate control. The unlisted developer, the Union Investment Real Estate fund, is promising nearly 1.5m sq ft.

Broadgate Tower

While you’re up this end of the City you could walk a few minutes further north to check out the 164m high Broadgate Tower. This is another British Land effort, and it’s notable for a variety of reasons, not least of which is that construction was delayed for years by the discovery of archeologically significant ruins. Much of the tower is built over the incoming train tracks to Liverpool Street station, with now-defunct Railtrack having granted the company air rights.

Nearby Occupy graffiti

This graffiti on a nearby building faces Broadgate Tower and the City. It’s nicely done, but in the context of all this development it sounds like a child refusing to eat his peas. But besides my ongoing sympathy with anyone frustrated at the banking blow-up and the huge rewards earned for such a monumental cock-up, they also got an extra vote because the gentrification around here is breathtaking and a little out of control. Traditionally it’s been a shabby area on the City fringes, with special areas like Folgate Street protected by anonymity. But as Spitalfields rolls into Brick Lane, it’s becoming tediously shiny.

30 Old Bailey

This isn’t anywhere near the other sites, but I’ve included 30 Old Bailey as an example of one of countless smaller building sites strewn between the City and Stratford, via the Isle of Dogs. According to Land Securities, it’s another 300,000 sq ft of new space on the way. If there’s truly another headcount cull in the financial sector, London is going to be THE town for cheap offices!

The Shard / London Bridge Quarter

Finally, at the other extreme, The Shard – or as nobody but the developer calls it, London Bridge Quarter. Differing from the others here in being (just) South of the River, The Shard will be the European Union’s largest building at 308m when it’s completed in May (although only 45th tallest in the world).

The scale when you get up close puts your heart in your mouth. I was there on a Sunday, and everybody I saw walking past looked up, like they were marveling at some super tall alien spaceship. I suppose this was what it was like in New York when they built the Empire State Building. Remarkable.

Make sure you come back next week for some practical ideas on how to invest in London property and offices via UK-listed property firms, especially if you are looking for income.

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