London Metric Property Hits the REIT Note

London-listed REITs had a tough first half of the year, but one company bucked the trend – London Metric Property shares are not only in positive territory year to date but even managed to gain promotion to the FTSE 100. Calls for a Deep Dive into the REIT to see if there are any pointers for the rest of the sector.

By Frank Buhagiar

In June 2024, LondonMetric Property (LMP) gained promotion to the FTSE 100. Some achievement, not just because the company was founded barely a decade ago in 2013, but also because the property sector as a whole has not been having the easiest of times lately.

Higher interest rates have made debt expensive; the elevated yields offered by risk-free assets, such as bonds and cash, have made it harder for property companies to compete for the investor’s pound; the working-from-home phenomenon has disrupted the office subsector; increased demand from occupiers for properties with the highest green credentials has raised the risk of older vintage assets becoming obsolete – just some of the factors that have weighed on the property sector in recent years. So much so that, according to CBRE, May 2024’s +0.2% capital value increase was the first positive movement seen across the UK commercial property sector since April 2023.

Against this backdrop, London’s REITs had a tough first half of the year. According to broker Winterflood, the FTSE EPRA NAREIT UK Index was down -2.4% in total return terms for the six months to 30 June 2024, some way off the FTSE All Share’s +7.4%. In all, 23 out of 29 investment companies in the sector generated negative share price returns over H1 2024. No surprise then that, over the Jan-Jun 2024 period, 22 out of 29 funds (84% of the sector’s market cap) were de-rated. No surprise either that the share prices of all investment companies in the property space were trading at discounts to NAV. And, as the graphic below from Winterflood shows, the same was true at the individual sub-sector level:

And yet, LondonMetric bucked the trend. Year to date, LMP’s share price is up around +6%, helping its shares to gain FTSE 100 promotion. So, what’s the secret of LMP’s success and are there any pointers for the rest of the sector?

Calls for a review of LMP’s latest full-year results which were released in June. Highlights include a total property return of +4.7%, some 570 basis points more than the IPD Index. This was primarily driven by ERV (Estimated Rental Value) growth of +5.7%. Outperformance, a good start.

And then there’s the first bullet point of the results announcement that neatly encapsulates the story: “Focus on winning sectors and transformational M&A drives rents, earnings and dividend growth”.

For winning sectors read the “structurally supported sectors of logistics, convenience, healthcare and entertainment”. Take logistics. The sector currently accounts for 43% of the portfolio but is expected to rise to over 50% over the next year – structural drivers here include the rise of e-commerce as well as supply-chain reconfiguration in favour of just-in-case strategies that have been increasingly in demand since the pandemic. Being in structurally supported sectors leads to strong fundamentals such as high occupancy rates (99.4%) and robust demand from occupiers. High occupancy rates and robust demand result in higher rents – rent reviews during the year resulted in a +19% increase in rents on a five-yearly equivalent basis; urban logistics saw an even more impressive +40% rental uplift. Higher rents drive positive financials.

For transformational M&A, read this year’s merger with LXi REIT which added £2.9 billion of assets and also the takeover of CT Property Trust which added another £0.3 billion. The merger activity saw the value of LMP’s portfolio double to £6.0 billion (31 March 2023: £3.0bn), while net contracted rent more than doubled to £340 million from £145 million previously.

No wonder CEO, Andrew Jones, describes the year as a transformational period for the Company which has seen the creation of the UK’s leading triple net lease REIT and the third largest UK REIT by market capitalisation according to Jones. “Scale and income granularity are increasingly important and our activity has further enhanced our sector leading income metrics with reliable, predictable and exceptional income growth.”

One reason why scale is becoming increasingly important is because wealth managers, historically important buyers of investment companies, are becoming larger. Last year, for example, saw the merger between Rathbones and Investec which created a manager with £100 billion of assets under management. As Winterflood explains in its January 2024 annual review, this led to some concerns that there could be forced selling, or at least subdued future demand. “If the merger (of Rathbones and Investec) led to the combined entity owning more than 30% of a fund’s shares (the threshold that would normally require a bid to be made under Takeover Panel rules).” So far, these concerns have failed to materialise but the broker expects an increased focus on larger, more liquid investment trusts from these groups, particularly “those with centralised investment propositions, and additional scrutiny on the relevance of sub-scale funds.”

Thanks to the above M&A activity, LMP appears to have responded to the changing market dynamic quicker than most. The title of a March 2024 note on LMP by JPMorgan neatly sums it up, “Bigger is better”. In the note, the broker uses the completion of the all-share merger with LXi to reinstate coverage of LMP with an overweight rating. According to JPMorgan the merger enhances the defensive characteristics and income security of LMP’s portfolio by diversifying across a broad range of resilient sectors (such as Entertainment and Healthcare) with high barriers to entry, strong underlying property fundamentals and attractive and sustainable rent income growth prospects – with a growing dividend target.

JPMorgan goes on to highlight a further benefit of the LXi acquisition – enhanced liquidity. “An impediment in real estate for investors when we go marketing has been liquidity. We note there has been a significant increase in share liquidity post-merger – the average trading volume for LMP for the last five days has been £11m, 2.7x higher than its average trading volume for the last 12 months.”

The Investors Chronicle is also a fan of the stock. In LondonMetric Property growing in moribund Reit market, the IC believes LMP’s results show initial promise as the company digests the £1.9bn merger with LXi. “However, there is still plenty of housekeeping to do before the company takes final shape.” Housekeeping involves selling off non-core assets such as the sale of Scottish offices for £37m that LMP announced alongside the results. At the time of the results, a further £107m of disposals were in the due diligence phase. The proceeds of the various sales have been earmarked to pay down debt or pursue new opportunities.

Quick note on valuation. The IC acknowledges that being “On a forward price/earnings (PE) of 15 times Peel Hunt’s forecasts for 2025, with only a narrow discount to net asset value (NAV) expected, LMP is not a cheap proposition”. However, “it is a growth company in an otherwise moribund Reit market. Buy.” Growth, another sought after quality.

Scale, liquidity, growth, M&A, outperformance, sectors – all would feature strongly in a word cloud on the LMP investment case. All it would seem are key takeaways for London’s REIT space today.

Of course, LMP, not the only fund to hit the acquisition trail – Tritax Big Box’s (BBOX) acquisition of UK Commercial Property for example, but LMP’s promotion to the FTSE 100 does make it a model for others to follow. Time will tell if other REITs do go down the LMP path. For now at least, there’s one REIT that may well look to capitalise on the still wide discounts on offer and snap up a sub-scale fund or two, LMP itself. After all, the £4 billion market cap does have form.