UK - UK REITs are entering unprecedented waters and are unlikely to achieve strong investor interest for at least a couple of years, according to Brend Stahli from Merrill Lynch.

The lack of debt available to investors coupled with the nature of property as a capital-intensive asset that is reliant on debt, means UK REITs are likely to suffer.

Speaking at the IPD pre-conference meeting yesterday, Stahli said: "The leverage at the moment is not there. The only buyer that is out there is buying [Reits] on a cash basis or with a very strong equity support.

"And then the issue is, 8-9% total return on a long return; part of it is income, part of it is rental growth. No one is going to be willing to undermine any rental growth assumption for the next two years because it effectively means that your income yield is your total return," said Stahli.

According to Stahli, the capital cycle needs to stabilise and investors will have to re-capitalise and consider re-financing in 2009.

The total return for REITs in the last 12 months was -1.0% and the derivative market is expecting the risk premium to go up. 

That said, the UK is in a better position than other European countries says Stahli.

"If anything the UK REITs are much better placed than many of their counterparts in Europe, where not only have the companies assumed that they would gear up with rising property values by actually keeping their leverage ratios constant, but if anything they have actually been increasing their leverage to ride the up cycle."

The UK public equity or listed sector is only 4% of the total real estate value of the market, however, the long-term prospects for REITs are more optimistic, suggested Leonard Geiger, director of European real estate securities research at Cohen & Steers UK.

"We think eventually, over time, that the listed market, particularly the REITs will grow. Interestingly, is it usually during downturns that REITs seem to take off", as was the case in the past for the US and Austrialia.

Experts predict there will be three changes in the medium-term for UK REITs: specialisation, new asset types and a focus on income.

"I think we will see over the medium-term a widening in the spectrum of property types in the REIT market and I do think that specialisation is a medium, if not a short-term, goal," said Dominic Smith, research manager at Land Securities.
At least 40% of UK REITs are specialist based on value but according to Smith, residential, hotel, leisure, retirement and infrastructure are among the ‘missing' REIT sectors.

UK REITs experienced strong capital performance and rental growth in 2007, thanks in part, to their control over capital and investments in riskier stocks, noted Malcolm Frodsham, director of research at IPD.

"The UK REITs generally performed very well, for 2007. They certainly outperformed the other fund types by basically having a lot more of the risky sectors and a lot of central London offices, and they also had the high yielding assets."

According to Frodsham, the freedom REITs have from an institutional framework and guidance to risk control - as to what sort of sector exposures and individual asset bets they are allowed to take - will continue to feed through to their performance in the future.

However, Frodsham admits UK REITs are likely to do worse next year: "That is the problem with investing in high beta sectors in the market and high beta assets."

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