Interest Rate Cuts Revitalize Real Estate Funds: Insights into REITs

The gradual reduction of interest rates in the UK and the US to an expected 4 to 4.75 percent is refocusing investors' attention on interest-sensitive sectors. Real estate investment trusts (REITs), which are based on substantial debt mountains and own, operate, or finance income-generating properties, are particularly affected. The sector faces various challenges, particularly in the office space, as concerns about home offices persist. While some well-established REITs are recovering, others are not yet in revival mode. A particularly turbulent entity is PRS Reit, where shareholders are rebelling due to a 35 percent discount on the net asset value (NAV). An activist group is pushing for changes and wants to appoint Robert Naylor and Christopher Mills to the board. Let's examine a few REITs that are currently less favored in the UK but deserve a closer look. First, Impact Healthcare is notable, impressing with strong income portfolios. Its shares are traded at 88.5 pence, with a discount of around 25 percent on NAV and a net yield of approximately 7.9 percent. The focus is on nursing homes, particularly for the elderly. Positive aspects include a low leverage ratio of about 28 percent, no imminent refinancing concerns, and continuously increasing dividends. However, there are concerns about "counterparty risk," as operators of the nursing homes may not meet their obligations. For instance, the fund had to replace the operator Silverline, which fell behind on payments for seven homes in January 2023. Residential Secure Income is a smaller fund with a market value of only £99.2 million and a portfolio mainly of shared ownership properties and independent retirement homes. The shares are traded at 53 pence, yielding 7.8 percent with a discount of about 30 percent. Weaker property prices in the UK have slightly reduced the NAV, although income is growing solidly due to high rental inflation. Concerns include a high leverage ratio of around 53 percent and upcoming debt repayments. Nevertheless, the underlying cash flows are strong and the dividends are well-covered. Finally, Regional Reit has faced challenges in recent months. The fund owns 135 regional office buildings with 1,344 office units and 906 tenants across the UK. Remote work has pushed the occupancy rate down to about 80 percent, and many regional cities are struggling with weak office markets. Sustainability requirements also have an impact, as 18 percent of the portfolio has a D energy efficiency rating or worse. Additionally, a high leverage ratio of over 50 percent and the repayment of a £50 million bond weighed on the fund's assets. Investors stayed away, leading to a discount of over 50 percent, and an emergency capital increase was necessary. This resulted in well-known housing entrepreneur Steve Morgan becoming the largest shareholder. The leverage ratio is now closer to 40 percent but could rise again with further devaluations. Future dividend yields are varied, but could be in double digits. Despite all challenges, Regional Reit could be well-positioned during an economic upturn and falling interest rates. For adventurous investors, there might be opportunities for total returns in the mid-double digits.