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TEMPUS

Music is fading for the warehouse party at Segro

The Times

Knowing when you’ve come too late to the party is up there with pinpointing just when to bank your gains as one of the more underappreciated challenges confronting investors. For those thinking about taking a punt on Segro, the warehouse landlord, the biggest call is judging whether future growth in rents and the value of its assets will be enough to justify the level of the premium in the share price.

The FTSE 100 group, formerly known as Slough Estates, was established a century ago when its founders set up a trading estate in the Berkshire town. Since then it has become the largest industrial developer and landlord in Europe and has overtaken Landsec, the office landlord, to become the largest property group listed on the London Stock Exchange.

Investor bullishness is understandable. The slow death of the high street has sapped rents for retail landlords, such as Hammerson and Capital & Counties, but Segro is on the right side of shoppers’ shift online. Rising demand for distribution warehouses has driven up rents, a phenomenon that increasing asset values is expected to continue. In fact, rising property prices mean that the investment yield — rent charged against the value of the asset — for prime warehouses is at the same level as offices in the City of London, according to CBRE, the consultancy.

It’s a simple case of supply and demand. The boom in online shopping during the pandemic caused a rush among retailers to open larger distribution centres. But the tight availability of land for logistics developments limits any boost to new warehouses. By the end of September, there was only 7.1 million sq ft of logistics space available, according to CBRE, equating to a vacancy rate of 1.53 per cent, the lowest on record.

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There’s a chance that some froth might come out of rents as the pandemic panic among retailers subsides. But take-up hasn’t suffered yet, nor has the amount that occupiers are willing to stump up for space: the £26 million in rent that Segro agreed during the third quarter was £10 million higher than in the same period last year; rents secured at review or renewal were an average 13 per cent ahead of previous passing rates and the vacancy rate declined to a mere 3.2 per cent.

If warehouse values are rising, then commercial landlords whose business models are predicated on purchasing tired warehouse space and revamping it may also see their returns eroded by having to pay more for acquisitions. Segro’s focus on developing new distribution centres mostly sidesteps this problem.

Scale does count. The heft of its development activity and exposure to the less mature urban logistics market in continental Europe partially justify a more beefy premium for Segro’s shares than smaller UK-listed peers, such as LondonMetric or Warehouse Reit. But Prologis, the US-listed industrial landlord that has a portfolio ten times the size of the British leader, has a share price only about 7 per cent higher than the net asset value forecast at the end of this year.

Segro’s shares trade at about a 31 per cent premium to the NAV forecast for this year, which demands that the rapid pace of growth in the portfolio continues. Yet annual NAV growth of 20 per cent forecast this year by analysts is expected to fall to a rate of 9 per cent and 6 per cent over the following two years, respectively. Investors could have more to gain from speculating on those smaller — and higher-dividend-yielding — stocks in the sector.
ADVICE
Hold
WHY
Much of the potential growth in rents and portfolio value seems accounted for by the generous premium attached to the shares

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Unite

Unite isn’t a simple post-pandemic reopening story. Campuses might be recovering and travel restrictions may be being loosened, but A-level grade inflation and changes to fees for European Union students still threaten earnings at the student landlord. Those uncertainties aren’t reflected in a share price that represents a 25 per cent premium to forecast net asset value at the end of this year.

Lettings for the 2021-22 academic year missed management’s expectations, at 94 per cent compared with guidance of 95 per cent to 98 per cent. More students receiving top grades meant a flight to top-tier universities and higher vacancies where lower-ranked universities are located.

Travel restrictions have continued to affect demand from China, but a fall in international lettings has been compounded by the scrapping of EU students’ access to student finance and increased fees this year. EU students might have accounted historically for only 8 per cent to 9 per cent of Unite’s tenant base, but a decline in EU applicants of more than 50 per cent this year was more dramatic than a fall of around a third that Unite had pencilled in. Earnings are expected to stabilise next year and to grow by between 6 per cent and 8 per cent a year thereafter. Analysts at Numis expect this to be reflected in an NAV of 922p a share at the end of next year, growth of 6 per cent on that forecast at the end of this year.

Will Unite disappoint again? Perhaps. Richard Smith, the chief executive, is counting on between 60 per cent and 70 per cent of the grade inflation to reverse during the next academic year, so occupancy in some university towns and cities could continue to fall short. He might hope that rising middle classes in places such as India and Indonesia and the forecast rise in the number of 18-year-olds in the UK will offset a fall in EU students, but those are slower-burning trends than the more immediate drop in applications from the Continent.

Rising asset values might be a reassuring indicator of growth in future rents, but the shares’ present valuation is not attractive given the lingering risks to occupancy and earnings.
ADVICE
Hold
WHY
The shares’ rich valuation is not attractive

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