A NAV conundrum faces the UK REIT market

The recent takeover of Capital & Regional by NewRiver REIT marks the latest example of consolidation in the UK REIT market, following other notable deals such as the LondonMetric takeover of LXi, as well as the merger between Tritax Big Box and UKCM.

This wave of corporate activity has been driven by several factors. One trend is the shift towards specialisation, with REITs increasingly differentiating themselves to investors by focusing on specific sectors.

Scale has also become an increasingly important factor, with larger REITs able to spread their fixed costs across a broader asset base, and achieving greater cost efficiency. Moreover, size can open doors to institutional financial products and services that are often inaccessible to smaller REITs.

A similar consolidation of wealth managers in the market and demand for liquidity means some are now avoiding smaller listed funds, as a large position in a smaller fund can hamper the ability to exit.

However, the discount to Net Asset Value (NAV) has arguably been the biggest catalyst behind the recent corporate consolidation activity within the REIT market.

Many listed property funds are currently trading below their asset value. This disconnection has restricted the ability of some REITs to raise funds through equity markets. As a result, corporate mergers and acquisitions have emerged as the primary way for REITs to expand their portfolios, given the combination of high debt costs and a reluctance to increase Loan-to-Value (LTV) ratios. With fewer attractive financing options, consolidation has provided REITs with an alternative pathway to growth.

The focus on NAV has become a major frustration for many REIT managers that feel that the emphasis on a discount to NAV unfairly skews investor perception.

There are those that feel an alternative focus on a fund’s earnings and its ability to cover dividends through earnings, would provide a far better performance metric for investors. This is how REITs are assessed in the US - the birthplace of REITs. The price-to-earnings ratio is a key metric used across all listed markets, so why does it not have equal prominence in the property investment sphere?

At a time when seasoned property investors believe the market is turning a corner, and the Bank of England is signalling a potential downward trajectory in interest rates, many REITs find themselves frustrated by limited access to capital. This inability to capitalise on discounted property prices, just as the market presents emerging opportunities, is a significant hurdle.

A rethinking of valuation metrics within the property investment industry is perhaps overdue to ensure that REITs can seize opportunities and not miss out on changing market conditions. Moving away from a sole focus on NAV towards more holistic performance metrics could unlock capital and revitalise growth in the sector.