Should investors take another look at a rebounding property sector? The INVESTING ANALYST

So far in 2025, the REIT space has been characterized by a flurry of M&A activity, as buyers look for bargains in a sector languishing at discounts across the board.

In this column, Alan Ray, investment trust research analyst at Kepler Partners, looks at why real estate investment trusts could offer an opportunity to shrewd investors.

The last few years have been full of contradictions for the listed property sector. First, the pandemic accelerated and cemented positive trends in areas such as logistics that had been underway for several years.

Share prices of REITs surged, seemingly in response. But then, in 2022, share prices came crashing down and wide discounts to net asset value became normal.

Property, as an income-generating asset class that is usually geared with debt, is naturally interest-rate sensitive and those surges and declines in share prices were really determined by the interest rate cycle, which is an enduring truth that it pays to keep in mind. Behind the scenes though, it has been a very different picture.

I'd point to two key trends that the pandemic accelerated. First, the re-wiring of the UK economy to embrace online commerce - requiring highly efficient and well-located logistics and industrial buildings - gathered pace, with countless anonymous square boxes humming with activity.

In our daily lives this manifests itself in the extraordinarily short space of time between ordering a £2 roll of masking tape and its appearance in the 'safe space' behind the wheelie bin, but this re-wiring has also profoundly changed interactions between businesses and how supply chains work.

Today, businesses are painfully aware of the fragility of 'just in time' international supply chains and are much more focused on local production and supply. And, in a much longer essay, we could also discuss the apparent reversal of globalisation that may push this trend even further.

Second, the changing nature of offices and how we use them. While some of the wilder pandemic fantasies about office life have proved to be exactly that, there have been profound changes to the way many of us work even when we are in an office.

Again, this trend may be accelerating post-pandemic as we grapple with the implications of AI on the nature of the work that humans do. Office buildings as an overall group have been harder to manage than industrial and logistics buildings, but there are clear positive trends for the right offices in the right locations.

There are many other trends to talk about, but these two sectors respectively form over half and a quarter of the value of UK commercial property. And in fact, many retail assets these days are hard to distinguish from a logistics hub so many of the same trends apply here.

But there are always going to be buildings in the wrong place at the wrong time, and I'm sure all of us can think of a 'stranded asset' - perhaps a dilapidated office with no hope of renovation or repurposing, with a 'space to let' sign outside.

Encounters like that can have an outsized influence on the way we think about property.

The reality for many property fund managers over the last few years has been a fight against big declines in share prices and a struggle to repay debt but in stark contrast tenants demanding more and better space, resulting in growing rental income. The right buildings in the right places have, from an income perspective, kept delivering.

So, did the stock market get things wrong in 2022 and were those share price falls unjustified? Bluntly, no.

The stock market called it about right and property valuations have fallen by 20 per cent or more since then. Zero interest rates had pushed property values too high, and things are back down to more sensible levels, with yields on many REITs now as high or higher than UK gilts.

Falling share prices did, however, catalyse a dizzying number of mergers and acquisitions. In some cases, private equity simply bought a REIT at a discount and took it private to harvest the growing income. But very often mergers have occurred between REITs.

LondonMetric (LMP), arguably the leading diversified REIT listed in the UK, has absorbed five others since 2019, building a £6bn portfolio focused on industrial and logistics, leisure and entertainment, healthcare and convenience retail. In many cases with long leases and contractual rental uplifts, giving good visibility for income growth over many years.

Similarly, Tritax Big Box (BBOX) has built a £6.5bn portfolio partly through acquisitions, focused on large regional logistics hubs and smaller urban logistics assets, leading to rental growth and a rising dividend.

While it's easy to dismiss such mergers as 'empire building', management teams need to get their share prices higher to get fully rewarded, so there's little point in buying another REIT unless you are confident that the assets can deliver.

Picton Property Income (PCTN) provides an interesting case study of self-help over the last few years. It owns a diversified portfolio, with over 60 per cent in the key industrial and logistics sectors. To help reduce its exposure to offices, management has taken several of these through planning permission to repurpose to much higher value residential assets, with one recent example having views towards St Paul's Cathedral.

This just goes to show that location can play an incredibly important role, and PCTN's selection of offices in the right locations has given it more options than would be true for our 'stranded asset' mentioned above.

While REITs themselves therefore present attractive opportunities for investors, one stalwart of the investment trust sector is TR Property (TRY), which owns a broadly diversified portfolio of REITs across the UK and Europe, together with a small portfolio of physical property in the UK.

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Owning a portfolio of REITs rather than buildings directly allows the management team to adapt more quickly, buying or selling shares in different REITs in a day rather than the weeks or months a property transaction might take.

TRY has a long history of dividend growth and might just be the right choice for the investor seeking the 'one and done' solution to commercial property in a portfolio.

I'd point to one last trend worth thinking about. While 'ESG' in wider investing remains a polarising subject, in property it is much less so. Here, the main elements - energy efficiency and simply put, decent air conditioning - are tangible, measurable and cost-saving. Efficient buildings are very likely to command higher rents.

Almost every property fund manager is paying attention to this, but Schroder Real Estate (SREI) has gone one step further, building sustainability goals into its investment strategy, and there is a strong correlation between higher rents and the manager's work to upgrade its buildings.

So to conclude, yes, the stock market called it right in 2022, sending share prices of REITs lower. But it's easy to see why property fund managers might have been perplexed, with many of their assets performing well.

With interest rates now at more normal levels, and a positive outlook for rental income in the right assets, this is a good time to take a fresh look at the UK's dynamic REIT sector.