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- [00:00]
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- [00:30]
IBM Representative
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- [00:59]
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- [02:03]
John Stebik
Welcome to Merdant Talks yous Money, the personal finance edition of Merton Talks Money. In these bonus podcasts, we talk about the best strategies for making the most of your money. I'm John Stebik, senior reporter for Bloomberg and author of the award winning Money Distilled newsletter Merrin's out today. But joining me in the studio very kindly is Jack Sidders, who is Bloomberg's team leader covering real estate and European investing. Jack, thanks very much for joining us today.
- [02:28]
Jack Sidders
Thanks very much for having me.
- [02:29]
John Stebik
So just to give you an idea of what we're going to cover, we're going to talk about what is a reit, a real estate investment trust. We're going to run through an overview of what's been a hectic five years for the sector in which it's basically halved in terms of the number of REITs that are on the UK stock market. And then we're going to talk about a particularly big deal that's going on in the REIT sector right now, where the biggest UK listed REIT is being targeted by a US peer. Jack's been on before and very kindly kind of talked to us about real estate investment trust. But just for listeners who are new to the show, perhaps give a quick reminder of what is a real estate investment trust. Jack?
- [03:08]
Jack Sidders
Yeah, sure thing. So. Well, real estate Investment trusts, or REITs, as they're commonly known, are basically publicly traded landlords. The REIT regime came in just after the global financial crisis about 20 years ago. And the idea is that unlike a conventional listed landlord that can kind of do whatever it likes with the money it makes, a REIT distributes the vast majority of its earnings in the form of dividends to shareholders. So mostly it owns investment properties, properties that are rented out to companies that generate a rent, and it pays those rents out in the form of dividends to shareholders. But they'll also do, or most of them will do a little bit of. They have a development portfolio as well, and that might be where they make their sort of development profits from building buildings, renting them out and then selling them on.
- [03:54]
John Stebik
Yeah, cool. So, yes, it's all about getting the rent and paying the dividends out. And they get various tax kind of accommodations.
- [04:01]
Jack Sidders
Exactly, yeah. The tax is key. I should have stopped it. So, yeah, so it's a sort of tax advantage structure so that you're not paying kind of double taxation. So they have some exceptions that other landlords don't benefit from.
- [04:17]
John Stebik
Obviously it's been an absolutely wild five years for most investments, but obviously things like Covid and the pandemic and working from home and the impact on office buildings and all the rest of it. Can you talk us through what's happened in the sector over the last five years? Because as I understand it, or certainly I've seen various statistics that say There were roughly 80 odd REITs in the UK listed about five years ago, and now that's going all the way down to about 40 or perhaps even slightly less. Can you talk us through why that's happened or how that's come about?
- [04:55]
Jack Sidders
Yeah, of course, there's a lot to unpack there. If we start off just talking about real estate, commercial real estate, very broadly, and then we can talk about the particular issues that have impacted the listed part of it and the reit sector in particular. But for real estate, I guess probably the most important thing fundamentally is interest rates and bond yields. So if interest rates in a time when interest rates were very, very low, and therefore bond yields are very, very low, real estate was seen as quite an attractive alternative in which to allocate capital because it was throwing off a bit more yield. So even though yields got sort of squeezed lower and lower and lower, and therefore real estate values pushed up higher and higher and higher, it was still offering a kind of premium over risk free rates, over government debt, over corporate debt as well. Now, come 2022, the sort of end of the cheap money era, risk free rates blow out, interest rates go up, bond yields go up. All of a sudden, real estate values had to adjust to reflect that reality, because why are you going to buy an illiquid building that is yielding less than a basically risk free government bond? You're not. So the value has to go down, the yield on the property has to go up in order to make it attractive. So that is the single most kind of important thing that has happened to commercial real estate as a whole over the last five years. Now, you mentioned there's then been a whole bunch different sort of structural issues within the different types of commercial real estate that have also had a huge impact. So we had Covid impact on offices, albeit that, you know, maybe a lot of that was more sentiment than reality. We've had the rise of online retail and how that's affected the shopping center, but conversely how that's affected the warehouse. So very simply, generally speaking, bad for shopping centers, good for warehouses. So those sorts of factors are at play as well. But then for the REIT sector in particular, so publicly traded real estate, now it's a funny kind of asset class because in theory it sort of should trade like any kind of commercial property. But the reality is these are publicly traded stocks and therefore they're subjected to kind of equity market volatility. So you mentioned that there were dozens and dozens and dozens of UK REITs, but lots of them were quite small. And one of the problems is it sort of doesn't necessarily take a much bigger team to run a publicly traded landlord that has 100 billion in assets than it does one that has 1 billion in assets. So what that means is small REITs are quite expensive to run, which is not great for shareholders. You've also then had the many and well documented issues with the UK market and the sort of general lack of liquidity in the UK market and UK assets generally trading at a Discount. So all of these things have kind of compounded the issues that, you know, all real estate, all UK real estate has had, but publicly traded UK real estate in particular has been a really unloved place for quite a long period of time now. Now how have management teams reacted to that and how have opportunistic investors reacted to that? A lot of deal making. So to start with, you had a lot of public to private deals. So private equity firms going, I can see that, that REIT is trading at a big discount to the sort of reported value of its properties. Therefore, if I can offer shareholders a bit of a premium to where the shares are trading right now, but still a discount to the value of their assets, well, the shareholders are happy and I'm happy cause then I can probably sell those assets on the private market and if I get book value, I'm making good money. So we had a whole load of public to private deals by the likes of Blackstone, Brookfield, et cetera. But then more recently we've also had a whole load of deals of sort of peer to peer deals where I might be a REIT trading a discount, you might be a REIT trading at a discount, but if we do a kind of all share deal, it kind of doesn't really matter. It's good in theory for shareholders because then we have a bigger asset base, bigger company, more efficient to run, lower cost to run, maybe we get into a bigger index, so we might go up into the FTSE 100 and therefore we get more passive investment, wider pool of shareholders, all of which is good. So that's been a huge driver of consolidation within the sector, all of which has ended up where we are today with the biggest REIT in the UK now the subject to interest from the Goliath, the Godzilla of publicly traded real estate globally. Prologis.
- [09:04]
John Stebik
Yeah, I mean this is a massive deal. There's one thing I just wanted to, to ask you about that. I think your point about costs of managing our portfolio is really interesting. Just before we get to Prologis, why did so many basically subscale REITs actually get off the ground in the first place? Was it just because it was a time of cheap money or was it because I noticed that a lot of it's very niche. If you go back, it's like doctor Surgeries or that sort of thing. Lots of different. And I'm just wondering what it was that made it, I guess, feasible for these companies to launch kind of essentially very tiny portfolios. Yeah, get them off the ground.
- [09:45]
Jack Sidders
It's a good question. And the answer to that would sort of vary with, you know, there's many different stories behind each kind of different data. But if you take, for example, Unite, they are the UK's biggest publicly traded student landlord. Now, 20 years ago, student housing was sort of non existent as an institutional asset class. It was really, wasn't really a thing. Unite, they managed to raise a small amount of money, IPO'd and they've really ridden this huge wave of investment into higher education or accommodation for students, and have done fantastically well. And it's developed from what was an incredibly obscure niche asset class. It's now quite a mainstay real estate investment. You know, you look at, look at Blackstone, the world's biggest real estate investor. Their single biggest sort of bet in UK real estate is in student housing. So it's become this very mainstream asset. Now, that's a great story. If you were there in the early, right at the start with Unite, you've done fantastically well, albeit the last couple of years, maybe less so. So there have been lots of enterprising people who've gone, right, I think this sector or that sector is going to be the next big thing. So they've maybe raised a bit of capital and then for whatever reason, it hasn't quite worked out. Again, some of it is timing. We saw after 2022, when rates blew out, all the REIT share prices collapsed. There were people who were then going out, talking to investors, going, right, this is the start of a new cycle. This is the time, let's raise some capital. But the trouble is we then had other shocks that then meant that those companies, maybe they did list, they raised a small amount of capital, but then very quickly they were trading at a discount and then they can't raise any more capital and they're kind of stuck. And so we just had lots and lots of these minnows who did manage to get off the ground, but then never got any further. And they've just been consolidated. Basically all these subscale players have started to be consolidated.
- [11:31]
John Stebik
Yeah, no, that makes a lot of sense. So I say consolidation, that takes us to the kind of deal of the day. So talk us through. Segro is the biggest real estate investment trust listed in the UK and it's a top, it's in the FTSE 50, basically, it's the top end of the FTSE 100. So it's a big, big company. Do you want to talk us through what it does and what the deal is with Prologis Yeah, sure, yeah.
- [11:55]
Jack Sidders
I mean they would be crown jewels of UK publicly traded real estate and actually their origin story itself is quite interesting, particularly when it comes to M and A. So they're principally a warehouse landlord. They, they rent out warehouses to, you know, various different types of industrial occupiers and increasingly these days to online retailers and people like that. They, so historically commercial real estate, you would have said the three big sectors were offices, retail and warehouses and offices and retail would have been the kind of twin aristocracies and sheds would have been the like the unsexy bit. So sheds being what people in commercial real estate call warehouses. And so for your big pension fund, and this is very crudely speaking, maybe they would have had 40% of the portfolio in offices, 40% in retail and 20% in warehouses. Now these days that allocation has been completely upended and is way more diverse. But the big story has probably been the massive reduction in the allocation to retail and the massive increase in the allocation to industrial and warehouses and logistics because of the rise of online shopping. The rental growth has been unbelievable. Seagro, previously known as Slough Estates. Glamorous, exactly, yeah. Reflecting that sort of prime asset to the west of London, very popular place for warehouses and these days increasingly data centers. And we'll come on to that. They did a very, very well timed deal just during the gfc. They bought a company called Brixton which they sort of appear of theirs, which was very, very over levered, as were they all at that point. And it had a lot of vacancy in its portfolio. They managed to buy them in about 2009, pretty cheap, basically rescued them. And what that meant was they then sort of significantly expanded their portfolio and they had a lot of space to let just as the E commerce story was just kind of starting to take off now it would be a few years before that really became clear. But basically over the last 10, 15 years they have benefited massively from that. Just all this extra demand not only from Amazon but also from conventional retailers who've gone what's known as omnichannel and now do online and physical retail. So that's the sort of backbone of their business, not just uk big portfolio in Europe as well. Then over the last several years the story has evolved. The really hot sexy area within the world of industrial logistics became what's known as kind of last mile or urban logistics. And those are the small warehouses near our houses, which retailers which are really sought after by people who want to deliver to us because fine, if you're talking about the uk and you're, you know, big retailer, you're John Lewis, you know, or Amazon. You probably put your massive, massive warehouse, your mega shed. You put that somewhere in the Midlands near the M1, near the M6.
- [14:39]
John Stebik
This is big box.
- [14:40]
Jack Sidders
That's what.
- [14:41]
John Stebik
That's the one where you see a big box.
- [14:42]
Jack Sidders
If you drive up the M1 past Northampton, you'll just see all. Which is where I grew up. You see all these huge, huge warehouses and they're the ones that are designed to kind of serve the whole country. So you can drive anywhere within eight hours from there, which is how long drivers are allowed to drive. So, ideal place to put it, but that doesn't really help with your same day delivery or your next day delivery. So what then Amazon or their peers need is lots of little warehouses very close to where we live. Urban logistics. And the rents for those have gone absolutely through the roof, partly because they're competing for space. You know, live in cities like London, there's not enough housing, there's not enough all sorts of things. So all of those are under pressure from other uses. So even if you, you know, if you own one of those and you're struggling to rent it, which, you know, in the current market is quite unlikely, but even if you were struggling to rent it as a warehous, well, you can probably make a lot of money from converting it to residential. So that subsector has done very well. And again, Seagro has got quite a big portfolio there. And now the future story for Seagro is the data center part, which is something that they've just sort of relatively tentatively started to talk about over the last few years, maybe a bit more vocally over the last year or two, where they have a lot of what's called powered land. So they have these sites that have access to power, which is the critical thing when it comes to data centers. And as mentioned, they have a lot of these, a lot of land in West London, in Slough, which is actually a key corridor for a lot of this stuff. So there's loads of potential to build data centers on land that they own, some of which, you know, previously would have been warehouses. So if you're a warehouse landlord and all of them have been doing this, you've been going through your portfolio for the last couple of years, going, this was a warehouse that I was renting out for 10 quid a square foot to some, you know, company that makes widgets. Actually, it's got power. I could convert it to a data center, and maybe a hyperscaler will take it and pay me a hell of a lot more than £10 a square foot.
- [16:28]
John Stebik
So this is basically stuff that's just ready to go as data centers rather than. They haven't actually. They don't own any data centers.
- [16:35]
Jack Sidders
Yeah, well, so they have a very small amount of kind of operational data centers, but it's basically, it's a development story. It's a powered land story. And what Segro and some of their peers have been doing today is they're not data center specialists. They haven't got a, a long track record of building this stuff. So they've either been partnering with data center specialists or sort of, yeah, just developing stuff to sort of shell and core, so to speak. And then a specialist comes in and does some of the more technical stuff. Now, as time goes on, they might acquire that expertise. They might look to take on some of this data center development directly themselves. But we'll see how that story evolves. But that is one of the things that's kind of central to this debate about whether or not prologis interest in CGRO is, you know, at fair value.
- [17:25]
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- [18:25]
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- [19:21]
Jack Sidders
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- [19:35]
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- [20:08]
John Stebik
So prologis come along. It's an all share deal and so basically if you're a Sagro shareholder you'll get a bit of the combined entity and what is it? It's the current price is roughly eight pound something or other, isn't it? Yeah, started above nine pounds but because share prices have changed.
- [20:27]
Jack Sidders
Exactly. Yeah. So when they initially so interestingly prologis approached Seagro's board made a proposal, Seagro's board unanimously rejected it. Prologis then basically immediately went public and said we're going to tell the market we've made this proposal to. So they didn't go back and make another offer which I think is interesting in of itself. That proposal at the time valued seagro at about £925 a share, which wouldn't you know is basically exactly in line with Seagro's net asset value, their Nova, their last reported one. So essentially we will pay you Seagro shareholders what the company says the assets are worth. And given that the company at the time was trading at about a 20% discount to its nav, okay, that's a 20% premium to the undisturbed share price. Now Seagro obviously immediately turn around and go well hang on a second, our share price has been walloped by Iran and actually if you compare it to the share price pre Iran, it's not a very hefty premium and Also the Navy. It's quite a conservative, backward looking sort of measure that doesn't ascribe a huge amount of value to the sort of potential future earnings in our development pipeline.
- [21:36]
John Stebik
So you're not pricing in the data centers, basically, or at least not fairly pricing in the data center.
- [21:40]
Jack Sidders
Exactly, exactly. So Seagro, as part of its defence today, has come out with a document or with valuations done for it by cbre, trying to kind of show the value that they think there is there, the future earnings that there will be from their data center pipeline. And wouldn't you know it, it's a lot.
- [22:00]
John Stebik
It's just NAV plus optimism type of.
- [22:03]
Jack Sidders
Yes, yeah. And to be fair to Seagro, this, you know, this is not just purely hope value. There are different ways of assessing real estate and actually this deal kind of perfectly highlights it. Because the UK arguably may be a little bit anachronistic, we still tend to think about NAV as a sort of key metric for understanding real estate value and how we talk about REITs and REIT valuations. Although a lot of analysts would tear their hair out and say, please don't, but we do when we have these deals, we talk about, is it a discount Nav, is it a preference?
- [22:34]
John Stebik
What do analysts prefer? In this sector?
- [22:38]
Jack Sidders
We focus more on earnings, which is how the US do actually value their companies. Because I immediately did this when the deal was, well, when the proposal was announced. Right. So this is roughly in line with nav. How are you, the peers in the us, trading where you can't. They don't publish their NAV in the same way, but what you can say, they focus on earnings, they focus on FFO and metrics like that, funds from operations. What you can see is particularly the data center landlords in the us, Digital realty, Equinix, people like that are trading on really, really elevated multiples to earnings, which it's not an apples to apples thing, but I think it's fair to say they would essentially be trading at a big premium to nav, which is kind of the market awarding a lot of hope value there. And you do see that in the uk, sometimes when the stock market decides, right, we're at the start of the cycle, we can see that values are at a bottom and they're about to go up. Hopefully rents are about to go up because no one's built anything. The sector will sometimes then trade at a slight premium. And then Seagro itself was trading at a bit of a premium for a few years before 2022. Which was to do with the fact that there was a scarcity of warehouse space. Rents were going up very, very fast. So the market was willing to price in a bit of that future growth.
- [23:58]
John Stebik
It does feel a little bit like that classic UK US valuation gap. More broadly, all the tech stocks went less than the US because people actually put a price on them that they feel is more reflective of their potential, et cetera. That's interesting. We don't know what will happen with this deal one way or the other. It's clearly in progress. But again, going back to the fact this is the biggest REIT in the UK by quite a long way. It's like a fifth of the sector or something like that. Accounts for by market value. How much more consolidation can there be left in the sector, if you like, at this point?
- [24:37]
Jack Sidders
It's a really interesting question. There was a bit of a sense that it had maybe been slowing down slightly from a somewhat frenetic pace. But that said, I mean, a be interesting to see what impact this deal, were it to happen then, has. And actually also in terms of potentially some new companies coming to market, Bloomberg reported the other day that Blackstone has done some very initial investor meetings on a company called Indurant, which is one of its portfolio companies, which owns a lot of UK warehouses, which, if Seagray were to disappear as a publicly traded UK name, maybe there'd be a new one. Yeah, just. Well, this is not something to be clear that we're reporting is going to happen anytime particularly soon. But very, very early on, that is
- [25:21]
John Stebik
the glimmerings of a potential pain, possibly.
- [25:24]
Jack Sidders
But if we go back to what we were talking about earlier and cost and that being a driver of consolidation, clearly there's a lot more to be done.
- [25:34]
John Stebik
Right.
- [25:35]
Jack Sidders
We've got multiple. For example, let's take London offices, where you've got two London office REITs that are both arguably still somewhat subscale. So that'd be great. Portland and Derwent, London. For many, many years there's been speculation about, well, could they do something, would they do something? Now, obviously, neither management team is going to be terribly incentivized to do that and do themselves out of a job. But there's that as an opportunity. You've got some landlords trying to pivot into different sectors and again, potentially an opportunity there to sort of take out subscale businesses in those new sectors that they want to get into. And again today, what do you know? Trump talking about the Iran ceasefire being over straight away, all the real estate stocks have sold off again, some more opportunistic private equity capital waiting in the wings if that is to persist and those discounts blow out again. There's several UK REITs that are still trading at really quite massive discounts to their reported asset value.
- [26:34]
John Stebik
I mean, I do think this is, and I guess this must be frustrating for people in the sector, but at the same time, if you are an investor, a kind of private investor, and obviously nothing on this podcast is a recommendation or anything like that. If you're of the view that interest rates in the UK are probably or possibly going to come down, or that the market is overly pessimistic about the direction of rates, rather the things are going to keep going up, then REITs are a fairly interest rate sensitive sector and a fairly obvious way you play those hunches one way or the other. But beyond that, there is also, there is quite, as you say, most of these are trading at fairly solid discounts to their net asset value.
- [27:17]
Jack Sidders
It's cheap. The sector is cheap.
- [27:19]
John Stebik
From a contrarian value point of view,
- [27:21]
Jack Sidders
yes, there's a whole load of different ways you can slice it and dice it, but basically the UK REIT sector right now is on a massive, massive sale. Yes. And if you're willing to take a view that probably we are, you know, the direction of rates is more likely to be steady or down than it is up, then, you know, then that would be a buy signal. There's also, you know, it's not just interest rates. The actual value that management teams bring here is supposed to be on the operational side. So in terms of increasing rents, increasing earnings, well, that side of the ledger actually looks pretty positive for the reason being that, you know, going back even further, we've had Brexit, then we had the pandemic, then we've had, you know, runaway inflation, so a whole series of bad shocks, which kind of means across most sectors, no one's really built very much for 10 years plus now in the UK, whether that's offices, you know, retail, no one's built anything because we had far too much retail. Warehouse development has still got on, but it got on. But even a lot of that was kind of upended by the end of the Cheap Money era. So there isn't, there's certainly not oversupply in many, if any sectors. And in quite a few of the sectors, there's really quite chronic undersupply. And assuming that the economy, you know, okay, the economy has not been going great guns, but assuming it sort of continues to just about tick along that should mean that rental growth is pretty robust and therefore that should be a good growth opportunity.
- [28:45]
John Stebik
Yes. And the credit and the micro side, because the other, I think that is something we haven't really talked about, but because the other big issue for investors is if you're afraid there's going to be a recession, that means lots of empty premises means lots of the landlords carrying a lot of voids basically. And that's actually something that we haven't really seen because working from home didn't end up being permanent and we didn't have a massive recession at any point over the last five years, despite all the kind of expectation that we would. So as you say, the actual operational side of the industry has been pretty robust.
- [29:20]
Jack Sidders
Yeah, I mean the other thing to say on that point is if you go back to the last really painful recession, I mean, putting the pandemic to one side that we had here in the financial crisis, yes, obviously there were huge credit issues within landlords portfolios in terms of their tenants, but even then vacancy didn't actually get that bad. I mean, yes, it got worse, but it wasn't existential. The real problem was the fact they were all massively over leveraged. And that was the big issue, that they have learned their lesson. The UK REITs have learned their lesson and as a sector they are not, generally speaking, significantly over leveraged now. They are generally carrying pretty conservative levels of leverage which even if there were to be some other significant shock that came along now which suddenly pushed real estate values down significantly again, they've still got a lot of headroom. So that kind of major threat to the sector they've largely dealt with.
- [30:14]
John Stebik
Yeah, so pretty resilient. Well look Jack, that was really, really useful. Really appreciate your time and thanks very much for coming in again. I'm sure we'll get you back in when we find out what actually happens with this Seagrow deal.
- [30:27]
Jack Sidders
Yeah. Yes. Well, I'm sure it'll keep me busy for some time to come, but thank you so much for having me.
- [30:36]
John Stebik
Thanks for listening to this week's Mairin Talks yous Money. If you like our show, rate, review and subscribe wherever you listen to podcast podcasts. Also be sure to follow me on X at jonstepec. You can Find Jack on LinkedIn. The family saw the most exciting of all social media outlets. This episode was produced by Summer Saadi and Moses Andam. Questions and comments on this show and all our shows are always welcome. Our show email is marinmoneyloombird.net.
- [31:11]
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- [31:40]
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- [31:43]
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- [31:48]
Jack Sidders
I'm Nathan Hager.
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