British Land Stock: Too Much Fear Provides Opportunity

British Land Company Plc (OTCPK:BTLCY) is a diversified Real Estate Investment Trust trading at a substantial discount to Net Asset Value, with an attractive dividend yield of about 5.5%.

Its focus is on value-add opportunities which exploits its deep asset management and development capabilities. Its approach is to source value-add opportunities – targeting value accretive acquisitions in the market and creating development opportunities for its portfolio which plays to its strengths. The company aims to develop and actively manage, creating modern, high quality and sustainable space which it manages itself to respond to customer needs. By recycling capital, meaning rotating out of assets where it has delivered its business plan and into opportunities where it can drive stronger returns through asset management or development. Its target is to deliver total accounting returns of 8-10% through the cycle. In the current macro environment management believes it is important to drive growth organically.

The London shares are down 22% year to date, as investors fear rising invest rates. The bear market in the shares could provide an entry point for investors as I think the discount of about 40% to the REIT’s Net Asset Value compensates for the risk of further falls in property values and rental income. There is a narrative that inflation could be bad for this stock, given the high levels of inflation in the UK currently, but in fact, historically, real estate has been an excellent inflation hedge.

British Land released its half-year report on November 16 and the value of this London office landlord’s real estate during the six months to 30 September 2022 fell by 3%, and the net tangible asset value fell by 4.4% to 695p a share. With London shares trading at 415p a share as of this writing, that’s a 40.3% discount to Net Asset Value. With UK interest rates probably still in hawkish mode, London stockbroker forecasts British Land will need to reduce its net tangible assets for year end March 2023 by 11% to about 600p per share. If that does indeed play out, the shares, at 415p currently, would still be at a 35% discount to net tangible assets. While discounts are common, discounts of this magnitude suggest extreme pessimism, presenting a margin of safety for long term investors.

The business

British Land’s business segments comprise Campuses and Retail & Fulfilment. Within this management are focusing on the following three strategic themes, and are targeting opportunities which play best to its skill set and where it sees the most attractive opportunities to drive future returns:

• Campuses – leveraging the Campus proposition to focus on customers in growth and innovation sectors including science, technology and health;
• Retail Parks – aligned to the growth of convenience and omni-channel; and
• London Urban Logistics – where British Land is delivering new space in a chronically undersupplied market via repurposing and densification.

Guidance for rental value growth for its core, office-led London “campuses” has been raised to 2% to 4%, up from 1% to 3% guided in May. The company has been boosted by letting office space 18% ahead of valuers’ expectations over the six months to the end of September. The increased annual guidance indicates an acceleration in rental values in the second half of this financial year 22/23, compared with the 1.6% growth it saw in the first half. To be conservative I am focused towards the lower end of the guidance range.

Retail assets should probably attract greater caution. Retail parks, which have performed better than shopping centres, account for 21% of BL’s overall property portfolio, while shopping centres account for only 8%. There is also a tiny amount of “last-mile delivery” assets too. Retail parks recorded a decline in value of 3%. Properties were re-let 2.6% below previous rents relative to the first half of the financial year. We have seen bigger declines in the past, such as reductions of 10% to 15% in recent history. However, the occupancy rate of 97.5% will almost certainly give BL the upper hand in rent negotiations with tenants current and prospective.

Since 92% of costs related to completing its committed developed are fixed, BL has some good visibility on the returns it can expect to make, so its 8-10% returns seem quite reasonable. Rental renewals are mostly linked to inflation indexes so it is difficult for tenants to force anything much less.

The financing of its committed developments should not be an issue, as costs to complete are estimated at about £569 million. Since British Land has about £2 billion in cash and undrawn credit facilities, and debt refinancing before 2025, the balance sheet looks stable. The REIT disposed of nearly £1.2 billion in assets in the H1 of the financial year, which has added to its liquidity position. Unlike big London rival Land Securities, British Land has no formal divestiture plan, which gives it more flexibility and prevents any distressed selling.

Unlike in the crash of 2008, which hit the property sector as hard or harder than any other, with the exceptions of its cousin banking sector, balance sheets are generally in better position, meaning REITs can hold assets in any downturn and ride out any drawdown. For British Land specifically, its loan-to-value ratio of just 30.7% means it can stomach a 48% decline in the value of its portfolio before it is in danger of breaching banking covenants.

Conclusion

When certain sectors of the stock market are gripped by greed or fear, it’s important to step back and look at the fundamentals and assess if analogies being made to historic episodes are realistic or not. In this case, a repeat of 2008 would be an extreme tail-risk. I’m too experienced to ever say something is “never going to happen”. So I think the NAV discount of 35-40% compensates us for short-medium term risk. The other thing is to understand economics and finance. The narrative I am seeing that inflation is going to be really bad for REITs doesn’t make sense to me. Yes, higher interest rates will be problematic if you are over levered. But on the rental side, studies show that rental rates keep up with inflation over time and there is a reason for this, rental renewals are inflation indexed.

British Land invests in prime and modern properties with all of the Group’s properties being located in the UK and many of these are in London. London as the UK’s capital and economic engine is a lower risk region than pretty much every other.

Warren Buffett said be greedy when others are fearful. The equity market is too fearful of British Land’s prospects and its stock price gives plenty margin of safety.