- REIT raises rental growth guidance for 2024 after strong 2023
- Dividend increased yet again
- But net asset value (NAV) per share continues to slide
- London landlord now trades at 38% discount to NAV per share
“NVIDIA beats quarterly sales estimates by $2 billion and the AI silicon chip developer’s market capitalisation goes up by $277 billion in a single day. Derwent London raises the estimated rental value (ERV) of its prime London properties by 2% to 5% for 2024, or a good few million pounds, and investors just walk on by,” says AJ Bell investment director Russ Mould. “At £19.50, the real estate investment trust’s (REIT) shares trade no higher now than they did in autumn 2012 and at a discount of 38% to their net asset value (NAV) per share figure of £31.29. Investors are effectively saying they think the value of Derwent’s property portfolio is only going to go one way – and that is down.
Source: LSEG Datastream data
“You can see why they might think that. This loss of faith even in prime London sites could be due to a combination of factors, including the rise of working from home, or at least hybrid working, and its impact on demand for office space, the relentless onslaught that brick-and-mortar retailers face from online rivals and also the UK’s gradual slide into recession. Either way, Derwent London’s NAV per share fell by 14% in 2023 and bears of the stock will argue that the gap between the share price and book value is more likely to close through NAV going down, rather than the shares going up.
“NAV per share is already down by a fifth from its pre-pandemic high of 2019.
Source: Company accounts
“There is another factor at work and that is interest rates.
“Higher interest rates (and higher bond yields) drive up interest costs on property developers’ debt, drive down net asset valuations (thanks to how future cash flows from rents are valued using a higher discount rate) and make the dividend yield available from REITs look relatively less attractive when compared to the returns on assets such as cash and bonds, which are also, in theory, lower risk.
“Consensus analysts’ forecasts for a dividend payment of 81.4p for 2024 suggest Derwent London offers a 4.2% yield – less than the Bank of England base rate and only just matching the ten-year gilt yield (or the perceived risk-free rate) of 4.12%.
Source: Company accounts, Marketscreener, consensus analysts’ forecasts, LSEG Datastream data
“The good news is strong new lettings activity, which suggests fears over the long-term value of real estate are overdone. In 2023, new lettings surged to £28.4 million, the best figure since 2019, and those deals were done at levels above those implied by the year-end 2022 estimated rental value. This suggests there is strong appetite amongst tenants for new, well-designed prime London sites, such as Derwent’s new developments in Baker Street, as well as the EC1 and SW1 postcodes. Even if overall net rental income fell very slightly last year, this activity could lay the groundwork for higher rental income going forward, all other things being equal.
Source: Company accounts
“A deep recession could yet change things in this respect, but Derwent London does have a well-diversified, blue-chip tenant base. Media, business services, online leisure, fintech and financials were the five largest tenant industries at 64% of the rent roll in 2022, while the largest individual tenants (out of 379) were Expedia, G-Research, the public sector (at 5%), Burberry and Boston Consulting Group. Between them, they came to around one quarter of total rental income.
“And it is rent that funds the dividend and Derwent London has increased its dividend per share yet again, to extend a lengthy growth streak.
Source: Company accounts
“However, the market is more focused on falling NAVs than rising dividends right now and it may need a stabilisation in asset values to tempt back investors. It is noticeable that those REITs whose activities are centred upon offices, especially in London, and retail, trade at much deeper discounts to NAV than student housing or storage or healthcare specialists.
Source: Company accounts, LSEG Datastream data
“Improved rental income and higher new lettings activity could be one catalyst for this and stronger economic momentum in the UK could be another. Equally, interest rate cuts may help, too (providing they are not a response to a deep economic downturn). Rate cuts would increase the relative attraction of REITs’ dividend yields for a start, besides boosting economic activity over time.
“It may be that REITs’ share price malaise is the result of some degree of normalisation in the Bank of England’s monetary policy. Derwent London’s share price thrived during the ten-year-plus period of record low interest rates, as investors fell over themselves to find alternative sources of yield wherever they could. Now they can turn to cash or gilts once more and as a result Derwent London’s share price does not sit too far from where it was when the Bank of England base rate last exceeded 5%. Perhaps this process of adjustment to a new era of monetary policy (if that is what it is) is nearly done and fundamentals such as occupancy rates, rent, dividends and balance sheet will slowly come back to the fore once more (for better or worse).”
Source: LSEG Datastream data
