MAGAZINE: Consolidation wave sweeps through listed sector

European logistics specialist Tritax Eurobox (EBOX) has not traded at a premium to net asset value for two-and-a-half years, despite operating in investors’ favourite real estate sector.

And in June, Brookfield moved in, with the mighty private equity group confirming it was considering a cash bid for EBOX, putting the logistics REIT in play.

EBOX is far from alone among listed property companies in enduring a sharp re-rating after interest rates started to rise in 2022. But its persistent discount to net asset value – almost 34%, reflecting a market value of £434 mln on 3 June when Brookfield confirmed its interest – is worse than many others. Listed in July 2018, it is still relatively small with its 22 properties in Belgium, Germany and Spain valued at €1.46 bn as of 31 March 2024. With fairly high gearing of 43%, it has sold off €173 mln of assets to cut debt. Externally managed, its fee cost ratio is on the high side. All these things, and ironically the quality of its assets, appear to have made it vulnerable.

If Eurobox disappears, it will follow LXi REIT, which merged with LondonMetric Property in February and UK Commercial  Property REIT which was absorbed into Tritax Big Box REIT in another all-share  deal in May (see table below). Meanwhile, Brussels-listed Shurgard swallowed smaller self-storage company Lok’nStore in June, while Capital & Regional’s 38-year run on the London stock exchange could soon end if the approach from rival retail propco NewRiver REIT is successful.

The expectation is that there’s more consolidation to come. In large part because, as LondonMetric’s CEO Andrew Jones believes, the real estate market has now ‘passed the point of maximum pessimism’, and the targets are there, with plenty of unloved small REITs and property trusts struggling on the London stock exchange at deep discounts.

Colin Godfrey, the CEO of Tritax Big Box agrees: ‘Pretty well all REITs have been moving up and down with the macroeconomic tide. Our sector has largely been a proxy to debt following the change in the cost of capital. What will happen – and it’s probably not far off now, because I think we’ve hit the nadir in terms of property values – is that investors will wake up and start focusing far more on the micro. They’ll lift the bonnet and start working out what the differences are between these companies, which they haven’t done in recent times because they haven’t had the time and focus for it.’

As they do, he continues, ‘they will find that some companies that were flattered by yield compression up until the recent correction have no more tools in their tool box other than to just buy and sell. That may not cut the mustard in the new world’.

Scale and liquidity
Jones says another factor differentiating between REITs and driving their share prices, is scale. After their mergers this year, LondonMetric and Tritax Big Box each increased their market capitalisations to around £4 bn, moving them up into the top half a dozen or so UK REITs, and in LondonMetric’s case, into the FTSE 100. ‘Scale across the UK listed market has become increasingly more important; global investors want liquidity and in order for us to attract global investors into the UK listed space we have to give them scale,’ Jones says.

On the London stock exchange, he adds, ‘what became apparent as we came out of the Truss-Kwarteng budget in September 2022 was that real estate stocks repriced very quickly and some of those more illiquid names fell more heavily. Then there was little catalyst for them to bounce back – because which investor wants to buy a £200- £300 mln cap, no matter what the discount to NAV is?’

The fallout from that infamous budget provided an opportunity for LondonMetric to make a move on one subscale company, CT Property Trust, six months before LondonMetric’s more recent merger with LXi REIT.

‘We’d been looking at CTPT in the summer before the budget, we thought they had a good portfolio,’ Jones explains. ‘The budget came in September, the dust settled around Christmas and by the time we came back in New Year 2023, stocks repriced. CTPT’s price had fallen roughly from 90p to 50p a share, so all of a sudden it looked interesting for us. ‘Our shares had recovered, because we had more liquidity; we were trading at a tighter discount. Therefore there was an arbitrage, and that would allow both sets of shareholders to win out.’ An all-share deal worth £198.6 mln closed in August 2023.

External versus internal management
Some of the listed property trusts in play, or which could be in play, are not only illiquid, they are externally managed and their management fees seem sure to come more sharply into focus at a time of underperformance. As the CEO of an internally managed REIT, Jones is understandably on the side of internal management.

‘My view about internal or external is that internal is far preferable to external management today. I think the days of raising equity just to grow assets under management, that time has passed. And these externally managed vehicles that were set up back in the day, I don’t think they are necessarily fit for purpose,’ he asserts.

Tritax Big Box, on the other hand, is externally managed – Godfrey is joint CEO of Tritax Group and in his role as CEO of Big Box, reports into experienced Big Box board chairman Aubrey Adams. The acquisition of UK Commercial Property Trust was the merger of two externally managed portfolios and Godfrey points out that a reduction in their fees was just one of the benefits for UKCM shareholders.

‘There were cost synergies. Big Box has one of the lowest total expense ratios in the market with our marginal fee grid providing a 40 basis points fee cost. So, it offers our customers a good value deal and that’s particularly so for UKCM shareholders. They were paying the equivalent of 66 bps and that enhances potential dividend progression for them.’

While timing and opportunity drive M&A, both CEOs stress that a target’s portfolio quality is the most important factor in any takeover.

A good fit?
One question investors asked was whether their targets’ assets were actually a good fit? Tritax Big Box is a logistics specialist while UKCM was set up to be a balanced property trust. Godfrey says that UKCM’s £1.2 bn portfolio mix had evolved to 60% industrial and logistics and 40% other sectors. He believes some people didn’t appreciate this or the quality of its assets: ‘I’m not sure it had a single analyst covering its stock, actually.’ Those who knew, would also know the 60% of its logistics properties were smaller, last mile warehouses, rather than the big distribution hubs that Big Box is most focused on. Godfrey explains that Big Box is not changing its spots, but rather broadening its size categories ‘a little bit more’. UKCM’s acquisition takes the merged REITs’ smaller box portfolio to approaching 10% of the £6.3 bn total, ‘and that is complementary for our customers because it allows us to offer them further diversification in terms of building size and location’, he says.

Furthermore, the time to step up this complementary offer is now: the team would not have invested in last-mile urban logistics in the recent past, ‘because initial yields were in the 2%s! We thought that didn’t make sense. Instead, we were waiting for this point in the cycle where there was a market correction. Once it happened, that’s when we got our skates on’.

LXi REIT had no logistics properties and as LondonMetric had been focused on buying logistics in recent years, there was some head scratching about the deal. But Jones says LXi’s portfolio includes assets that his team liked in sectors such as entertainment and convenience retail. And doubters missed the point that triple net investing – secure, long-lease income – not the asset sectors necessarily, is the important thing in LondonMetric’s portfolio and strategy.

‘For the last 7-8 years we have done that with logistics, simply because that’s where we got a bigger bang for our buck in terms of rental growth,’ he states. ‘We’re not marrying the logistics sector, I’m happy to pivot. When the facts change, we’re happy to do that.’

Persuading the shareholders
All acquisitive property companies and private equity firms have lists of potential targets and views on timing but the hard part can be engaging, and then persuading, their target boards or shareholders.

Lok’nStore welcomed the open arms of larger peer Shurgard, which had been on the acquisition trail for some time. Europe’s largest self-storage company with 276 stores had over the past year picked up first Top Box and then Pickens in Germany, and was prepared to pay 1,110p per share for the UK-listed company and its 43 properties in a £378 mln cash deal. The price is a small premium to Lok’nStore’s highest-ever share price, hit back in 2022.

However, Capital & Regional’s 68% shareholder Growthpoint was not interested in an indicative cash-and-share offer from Vukile Property Fund, the Johannesburg-based REIT, leaving the way open potentially for NewRiver REIT to make a bid.

Before accepting Tritax Big Box’s offer, UK Commercial Property’s largest shareholder Phoenix Life (with 43.4%) had turned down an all-share merger offer from fellow diversified property trust Picton Property Income which at the time had £766 mln of assets. It is said that Phoenix didn’t back Picton’s proposal, because it would have been a merger of two subscale companies to form another relatively subscale business (see Tritax Big Box panel).

In externally managed companies, managers and boards can and do disagree, while key figures on boards can change at critical junctures. Industry veteran Peter Pereira Gray became chair of UKCM last year, and was a lone voice on the board against the Tritax Big Box takeover, arguing a better price could have been achieved if ‘other parties would have come forward had there been a more open and comprehensive sales process’. In March, in the case of Abrdn Property Income Trust (API), not enough API shareholders voted in favour of the board’s recommendation of an offer from Custodian Property Income REIT, despite the board and its chair James Clifton-Brown warning that the alternative of a managed wind-down risked not getting fair value for the trust’s properties.

Custodian’s chair, David MacLellan, said that in approaching API, Custodian was ‘heeding clear calls from the market regarding the need for consolidation amongst the listed REITs’. Custodian thus joined erstwhile rival for API, £1.1 bn Urban Logistics REIT which withdrew from the fray, as well as Picton, in being back at square one with regard to that objective.

Managed wind-downs
Meanwhile, the list of strategic reviews being carried out by the boards of subscale REITs keeps increasing in a mirror image of what has been going on in the UK’s private, open-ended retail fund sector – where many funds have or are winding down in the face of investor redemption requests. In May, the board of listed Abrdn European Logistics Income Fund announced it had opted for a managed wind-down, allowing up to 24 months to sell assets.

With no hint of understatement, it cited its challenges as: the materially uncovered annual target dividend of 5.64 cents (€) per share; a market capitalisation of £234 mln, ‘liable to deter some potential investors due to lower share liquidity’; and the shares trading at a significant and persistent discount to the net asset value per share.

In June it was the turn of Balanced Commercial Property Trust’s manager Columbia Threadneedle to report it had ‘received interest from a number of credible parties’ for its circa £1 bn portfolio. At the time, BCPT was trading at a 30% discount.

Against this backdrop, it doesn’t seem surprising that the first attempt to float a new balanced UK REIT for three years was a flop. In June, Special Opportunities REIT said it had not been able to get its minimum £250 mln fund raise – although three cornerstone investors had committed up to £119 mln – much less its £500 mln target.

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LondonMetric & LXi: goal is to be ‘the UK’s leading triple net lease REIT’
The merger with LXi REIT was in some ways an opportunistic deal for LondonMetric Property, says Andrew Jones. LXi was externally managed by the longstanding and widely respected team led by Nick Leslau and there was a view that maybe it wasn’t working so well between the management and the board and the board wanted a quick solution.

‘We were approached to see whether or not that would be something we would consider, and we looked at the assets and worked back to see what the right price was and whether that would be acceptable to the management and the board,’ Jones says.

It wasn’t a perfect fit, and LondonMetric encouraged the sale of some assets during the due diligence process, notably 66 of a larger portfolio of Travelodge hotels. More sales are planned but there was enough to like. ‘They had assembled an interesting set of assets in some very good sectors...there were no shopping malls and no big office investments. There was entertainment, hospitality, grocery, convenience retail...areas that we felt comfortable with,’ says Jones.

There will be more sales, although likely not of the big theme parks Thorpe Park or Alton Towers ‘which we like because consumers are going to spend more money on entertainment’.

Proceeds will be reinvested into triple net assets ‘where we think we’re going to get superior income growth, and that’s probably logistics, but it could be drivethroughs which we’re invested in, or it could be a retail park’.

LondonMetric also acquired the LXi management team, and Leslau and co-founder Sandy Gumm joined the LondonMetric board as non-executive directors. ‘We believe a REIT can be an incredible, income-compounding machine, and triple net allows us to do that more efficiently than going for a big development programme where your income is more lumpy,’ Jones sums up.

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Tritax Big Box & UKCM: boosting an income business that uses development
Tritax Big Box REIT had been tracking UK Commercial Property REIT when the Big Box board saw the announcement about Picton’s approach to UKCM. When UKCM shareholder Phoenix Life didn’t back the deal, Big Box approached Phoenix.

Big Box’s Colin Godfrey says: ‘We went to them and explained what we were seeking to do. They thought that was a very high quality proposition. They liked it, it solved the liquidity concerns for them. They loved the sector we’re in and its growth prospects, and they backed us.’

He goes on: ‘It is an attractive point in the market to acquire UKCM because their portfolio was written down by about 24% since June 2022 and we think that provides potential for value appreciation through yield compression in the near and medium term.’ Another benefit of the merger he highlights is the portfolio’s six urban logistics parks, several of which are in London and the south east. As well as extending the size range offer to tenants, ‘they provide us with the opportunity to capture rental growth more quickly for our investors, with more evidential points of reference’. That contrasts with Big Box’s existing portfolio of 100% let large properties which are reviewed five-yearly. ‘We’re moving from 90 leases to 290 leases, and that means we’ve got many more proof points.’

There are asset management opportunities too, with the UKCM industrial and logistics portfolio having a high, 38% reversion against passing rent (the Big Box portfolio is 23%).

He says the £475 mln of non-core, retail warehousing, supermarket, student, hotel, leisure and office properties will be sold over the next 24 months ‘and we think the market will come towards us’. Proceeds will be recycled to fund development capex. ‘We’re delivering our developments at approximately 7% yield on cost and that’s more accretive than holding that 40% of UKCM assets. It means we don’t have to sell core logistics assets that we’d prefer to hold.’

Coincidentally, the merger brought together two separate Abrdn interests: Abrdn managed UKCM while Abrdn also owns 60% of Tritax Management.