Real Estate Investment Trusts (REITS) that use too much leverage risk running into financial trouble, particularly during the current economic volatility, warns Matthew Norris, fund adviser at Gravis UK Listed Property Fund.
Norris says: “Appropriate levels of leverage allow REITs to access larger opportunity sets and to capture economies of scale. However, leverage acts as a magnifier of returns and must be used with care and consideration, this is especially true in times of economic uncertainty such as those created by the Covid-19 pandemic.”
While many UK REITs are well prepared for the current economic environment, with the loan-to-value for most REITS continuing to decline, Norris said the collapse of Britain’s largest shopping centre owner Intu, which operated with too much leverage, should serve as a clear warning of the dangers of high leverage. Meanwhile, Hammerson, the owner of 20 flagship European shopping centres, which reported 51% LTV at the end of the first half of 2020, has since announced asset sales and a dilutive rights issue.
Norris said that the firm’s property fund steers clear of debt.
“Using debt at a fund level to invest in REITs that also use debt can dramatically increase the risk. Instead, the preference is to actively search for management teams that own modern, well located real estate and that have adopted a well justified approach to the use of debt.”
According to Norris, the economic spill-over effects of the Coronavirus will continue to underline the importance of moderate levels of corporate leverage and active stock picking.
He adds: “As investor sentiment continues to improve those real estate companies with strong underlying rental cash flows and strong balance sheets are likely to continue to experience further appreciation in their share price.”
