Small operations impress as bigger rivals look to change

Recent results from the big real estate investment trusts have seen little dynamic commentary or sector leadership, leaving them looking flat-footed against more nimble property companies that have been investing well in the meantime.

It has been back to business as usual, although that business still seems to be much about simply tracking the vagaries of the market with some playing round the margins. It was unsurprising that most outperformed benchmarks in a rising market given the geared effect on returns.

This market recovery continues at pace, but there are serious doubts if this is going to be sustainable and the Reit sector needs clear strategies to generate returns in a market where there will be less net asset value momentum in a slow economy.

Value growth is likely to moderate at best, and at worst reverse. Sure, City prime rents are going up but then many buildings are over-rented and the list of potential occupiers is dwindling. Outside London, the picture is bleaker. Growth will be stagnant in retail rents and provincial offices and warehouses are largely oversupplied and undesired.

Against this backdrop, it is the smaller property companies, with seasoned management proved capable of capitalising in a downturn, that are impressing.

On Monday, David Lockhart’s NewRiver secured a £49m deal on the back of a new £250m partnership with Morgan Stanley. London & Stamford banked a profit of a third in 10 months on a building sold in Leeds last week, with other of its investments already returning 25 per cent. The two big deals carried out so far by Nick Leslau and Mike Brown’s Max Property are likely to pay out strongly.

Such performances are already being priced into some shares, but there are others to watch not trading as highly, such as Robert Ware’s Conygar, likely to be at the forefront of some clever deals and, like London & Stamford, no stranger to thinking big. Indeed, gossip links London & Stamford to an audacious £900m knockout bid for the portfolio of properties backed by the White Tower loan, which is expected to be broken up and partially marketed in the next few weeks.

The large Reits, in spite of being mandated by premiums of NAV to buy last year, are now late to the hunt for the sort of prime property they favour given steep competition from aggressive unlisted funds and private investors.

The specialists are making the money elsewhere, buying outside towns where they know an agent who knows a tenant, or acquiring in the knowledge that permission could be obtained to reconfigure profitably. Reits also employ good asset managers, but they need the money and the freedom to compete.

This year should be one of change for these big companies, be it ownership, structure or strategy. The demerger by Liberty was well-received by investors, tapping into the feeling that now is the time for getting the house in order.

The advent of Reits in the UK in 2007 also marked the turning point in the cycle, leaving the sector struggling for survival before most had celebrated second birthdays.

The structure was not to blame for the market crash but for the first time the sector can stand back to see what structures would most benefit from their costly conversions. The demerger of Land Securities in 2007 was not a bad idea, but its timing was awful. There is now a window to approach shareholders in the mood to see how new strategies play out.

Few Reits need to change so radically, of course. In fact, some would benefit from being unimaginative. Reits were designed as simple liquid vehicles for shareholders to gain good tax-efficient income from real estate, which is oddly a selling point card that few can justifiably claim at the moment given low dividends across the sector. There remains a place for the multi-sector behemoth Reits as simple index trackers, but yields need to be pushed higher to offset the lack of innovation on asset value – and there will need to be greater income cover from buying and managing the assets wisely.

Even so, specialist managements do appear to be the focus now, as happened in the US at the end of the 1990s crash. This would be helped should the government realise the advantages to the wider economy of extending legislation to include residential and mortgage Reits, which proved ideal exit vehicles for banks’ loan portfolios in the US.

There will also be new Reits from the existing pool of smaller companies, such as London & Stamford and Hansteen, drawn by access to the larger pool of investors. These companies – along with LxB, Max, NewRiver and whatever vehicle emerges headed by Andrew Jones, former British Land retail head – have marked a changing of the guard for the listed sector.

That it happens to be the old guard is a certain irony, of course.

dan.thomas@ft.com