Sector Screener: two property stocks with long-term growth potential

Timing the stock market is impossible. Ultimately, no investor knows exactly what will happen next. However, some periods undoubtedly represent a more favourable time to buy shares than others.

For example, the share prices of several real estate investment trusts (REITs) have fallen heavily over recent years in response to a challenging economic outlook. At sector level, REITs have declined by 35% since the start of 2022. This suggests that now could be an opportune time to buy them while they trade at depressed prices.

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Whether further share price declines take place in the short run is clearly a known unknown. After all, inflation still stands at more than twice the Bank of England’s 2% target, UK GDP growth was zero last quarter and interest rates could remain high for some time. As a result, the operating environment for REITs remains tough. But there are green shoots of recovery that suggest the bargain basement market valuations of REITs are set to become increasingly difficult to justify.

Indeed, annual inflation declined by 210 basis points in October and is expected to fall to below the Bank of England’s 2% target within two years, according to the central bank’s own forecasts. Alongside a drab prospective economic performance, this is likely to mean interest rate cuts at some point in 2024. The market consensus is for them to fall to 4.2% over the next three years, although negative GDP growth would be likely to expedite this process.

Falling interest rates are likely to prove highly positive for REITs. After all, lower borrowing costs will reduce the chances of them defaulting on debt that has become vastly more expensive to service over recent months.

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A more dovish monetary policy is also likely to positively catalyse GDP growth. Greater levels of economic activity would equate to a reduced prospect of tenants failing to pay rent, since demand for their products and services is likely to rise. A buoyant economy would prompt higher demand for commercial property, both among investors and tenants, with rents and valuations likely to increase, thereby culminating in higher share prices across the REIT sector. As such, purchasing lowly valued REITs now could prove to be a sound long-term move.

Logistics potential

Within the REIT sector, companies that are focused on warehouses and logistics assets could prove to be particularly strong performers over the coming years. As well as benefiting from the positive impact of falling interest rates and an improving economic outlook, they are set to experience a tailwind from a return to the retail sector’s longstanding trend towards e-commerce.

Prior to the pandemic, the proportion of retail sales conducted online had increased at a brisk pace. According to the Office for National Statistics (ONS), e-commerce sales rose from 7% of total retail sales in 2009 to 21% in 2019. The proportion of online sales then spiked to a high of 38% in January 2021, as Covid-induced lockdowns prompted a change in consumer behaviour, before declining sharply to 24% in August last year in response to the end of pandemic restrictions.

Over recent months, though, the longstanding trend towards online shopping has returned. Indeed, the proportion of retail sales conducted online has risen by two percentage points to 26% since last August’s low. This is beneficial for REITs that own logistics assets because it means higher demand from delivery firms and e-commerce companies.

While demand for logistics assets is on the up, supply remains constrained. There is a limited amount of suitable land available on which to build warehouses, especially close to urban areas. Furthermore, there is vast competition for available land from other uses, notably residential property, which exacerbates the supply shortage of suitable warehouse locations. This imbalance between rising demand and limited supply is likely to prompt higher valuations among logistics assets. In turn, this is set to increase the book value, and ultimately the market value, of REITs that own warehouses.

Source SharePad. Data as at 11 December 2023.

Segro

Source SharePad. Data as at 11 December 2023.

FTSE 100-listed Segro (LSE:SGRO) is in a strong position to capitalise on favourable market trends and an improving economic outlook. It owns a wide range of warehouses across the UK and Europe, with sites that are in close proximity to urban areas accounting for two-thirds of its assets by value.

Since the start of 2022, the company’s share price has declined by 42% as investors have demanded a wide margin of safety in response to falling property valuations. Indeed, its net asset value (NAV) per share declined by 15% in 2022 and subsequently fell by a further 3% in the first half of the current year.

As a result, the company’s shares now trade on a price-to-book (PB) ratio of around 0.9. This suggests that investors have factored in the prospect of a further decline in the market value of its assets. It also indicates that there is significant capital gain potential as trading conditions gradually improve.

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In the meantime, Segro has the financial strength to overcome the current period of economic difficulties. Its average cost of debt is just 2.9%, with 91% of its borrowings either fixed or capped. With no major debt maturities until 2026, by which time interest rates are widely expected to have fallen, and a loan-to-value (LTV) ratio of 34%, the firm’s balance sheet is relatively sound.

In its most recent quarter, the company’s like-for-like rental growth amounted to 5.1%, which contributed to a 1.9% rise in earnings per share. While this is a relatively subdued rate of growth, it is likely to significantly improve as economic activity levels increase. And with a pipeline of projects either currently under construction or in advanced pre-let discussions that amount to over 7% of its portfolio, it is well placed to deliver an improving financial performance and share price growth over the coming years.

Tritax Big Box

Source SharePad. Data as at 11 December 2023.

Similarly, FTSE 250-listed Tritax Big Box (LSE:BBOX) trades on a low valuation following its weak share price performance. Its share price has fallen by 35% since the start of 2022, with its NAV per share declining by 18% in the 2022 financial year. However, its NAV per share subsequently rose by 0.9% in the first half of the current year, which means its shares trade on a PB ratio of around 0.9. This suggests they offer a sufficiently wide margin of safety given ongoing sector-related uncertainty.

Despite its name alluding to a focus on larger logistics assets, the company’s pipeline contains a variety of warehouse sizes. Its vacancy rate bucked the national trend in the first half of the current financial year, with it falling by 0.2 percentage points to 1.9%. And with online retailers making up 21% of its customers, it is well placed to capitalise on their growth as e-commerce becomes an increasingly dominant part of the retail sector.

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Tritax Big Box’s weighted average cost of debt stands at 2.6%, with all its borrowings either fixed or hedged. Its LTV of 30% is modest, while an average of five years until debt maturity means it is unlikely to be significantly affected by presently high interest rates. With £550 million of available liquidity, it has the financial strength to overcome short-term challenges to capitalise on long-term growth opportunities.

Exactly when Tritax Big Box and Segro will experience improved operating conditions remains unclear. Although their share prices are relatively cheap, they could remain volatile while economic conditions are tough. But given their wide margins of safety, large pipelines, solid financial positions and the growth potential on offer within logistics assets, both REITs have long-term investment appeal.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.