Property companies are like other stocks but …

Unlike virtually every other sector in the UK equities markets, property companies or REITs are traditionally valued and priced on the basis of their net asset values (NAVs), and not on their corporate earnings. This makes it difficult for equity investors who ideally need to have a common metric so that they can compare the performance prospects between the sectors and allocate their capital accordingly. For some equities investors, it is easier to omit the sector entirely from their portfolio, as it only represents around 2% of the total market. For those who are running an income portfolio, however, there can be an attractiveness to the sector because of the relative security of the income. The pricing of the individual stocks is rarely exactly at the NAV but is normally at a discount or premium to the NAV. There are a number of arguments that suggest the ‘natural’ stock pricing level is at a discount to reflect the costs of managing a quoted company, tax (although REITs are largely tax transparent), etc. The historic average discount is around 15%, but the figure varies significantly over the cycle and between individual stocks. Theoretically the change over the cycle should be reflected in the asset valuations but in practice, the lagging effect of revaluing coupled with the generally poor liquidity of the direct market (which makes price discovery difficult) means that pricing in the equities market typically leads the direct market by about 10 months, although that figure can vary depending, in particular, the factors driving the direct market pricing: financial factors (such as changes in interest rates) are normally more rapidly reflected in the equities market compared to property factors (such as changing tenant demand(. Ther differences between the discounts applied by the market to individual stocks usually reflects the size of the stock, activities like development (which can add or detract from value depending on their success), the level of gearing (which can also add or detract from performance depending on the point in the cycle) but most specifically the sector(s) in which the companies operate. Currently the biggest single factor is the percentage of the portfolio in retail property: the greater the percentage, the greater the discount. Some stock discounts are around 50% to reflect that, although the discounts will reduce as the direct market valuations adjust the portfolio vaue downwards and the stock prices (assuming that the market has got the pricing correct) more or less remains unchanged. The company’s quoted NAV/share (the normal measure of NAV) will often be different to the Balance Sheet NAV/share. This is a reflection of the different account treatments. In particular, some property (awaiting development or trading) will be shown in the Balance Sheet at cost, but revalued for the purposes of calculating the NAV/share. Conversely, most companies capitalise their interest on developments and revalue their developments in progress. Accounting treatments now vary much less between companies than previously. One similarity between the property companies/REITs is that there have been some reductions in dividends in 2020. Collecting rents from tenants who may be running at reduced levels of profitability or, in many cases, at losses can be difficult. Many landlords have agreed to switch from quarterly payments in advance to monthly in advance and/or reductions in rents or, in some cases, rent holidays. Of course, the worst rent collection is in the retail sector, with most shops being closed As the lock-down eases in 2021, this situation will recover, although it is difficult to say at this stage what permanent damage has been done to value by Covid 19. This loss of rental income has, it appears, only really been reflected in the values of property where the impairment in value is expected to be permanent. Again, it is the retail sector where this is most likely to apply. Otherwise, investment demand for property remains relatively robust, albeit not as strong as it was before the pandemic.