Morning Note: Market news and an update from Tritax Big Box REIT.

Market News

US inflation fell to 2.4% in the year to January (or 2.8% for the core measure), boosting hopes for rates cuts later in the year. The PCE measure is the Fed’s preferred gauge of inflation. The reading was the lowest for three years and is down from a peak of 7.1% in June 2022. US equity markets moved high following the data: S&P 500 (+0.5%), Nasdaq (+0.9%). The 10-year Treasury yield slipped to 4.27%. Pimco warned that US fiscal profligacy threatens to drag the Treasury market “back to the future.” In the 1980s, bond vigilantes demanded far higher compensation for longer-dated bonds. Gold moved up to $2,044 an ounce.

This morning, the Nikkei 225 climbed to an intraday record (+1.9%), leading Asia stocks higher: Hang Seng (+0.5%); Shanghai Composite (+0.4%). The yen weakened on Kazuo Ueda’s comments. China’s manufacturing PMI came in at 49.1 in February, shrinking for a fifth month as weak demand hampered growth. However, the widely followed Caixin manufacturing index reached 50.9, slightly better than expected, while the non-manufacturing index rose to 51.4, also above the 50 growth level.

According to Nationwide, UK house prices rose more than expected in February, posting their first annual increase in more than a year. Prices were 1.2% higher, taking the average to £260,420. Sterling trades at $1.2633 and €1.1680. The FTSE 100 is currently trading 0.6% higher at 7,675.

Brent trades at $82 a barrel. US crude consumption surged to a four-year high last year and may edge up further by 160,000 barrels a day to 20.4m b/d in 2024, according to the EIA.

Property News

Tritax Big Box REIT has this morning released its 2023 results. The statement highlights the ongoing strategic delivery and resilient income growth. The dividend has been raised by 4.3%. In response, the shares are up 1% and trade on a large 16% discount to NAV.

Tritax is a real estate investment trust dedicated to investing in very large logistics warehouse assets, or Big Boxes, in the UK. Over time, the group has evolved from an income-led asset aggregator into an integrated investment and development company. The £5bn portfolio is spread across 78 assets and around 60 institutional quality tenants, with a weighted average unexpired lease term of 11.4 years. The largest tenant is Amazon, representing c. 14.6% of rental income.

Through Tritax Symmetry, the group owns a strategic land portfolio for the development of Big Box assets of more than 40m sq ft (including land options). This provides the opportunity to more than double the company’s existing rent roll over the next decade. The group aims to minimise risk by primarily undertaking developments which are pre-let to a tenant – speculative development is less than 1% of asset value. The company believes these opportunities can be delivered at a yield on cost significantly higher than is currently available from acquisitions of built and let or pre-let forward-funded assets, with a 6%-8% yield target.

We believe the long-term outlook for the UK’s logistics sector remain favourable, supported by the continued growth in e-commerce, the consolidation of logistics networks into fewer, larger, more modern and efficient buildings, the need to build resilience into supply chains, and the increased focus on ESG. At a time when occupiers need a robust and flexible supply chain, the assets are essential to their business and cannot be easily replicated. We note that property costs are typically as little as 1% of total operational costs for a retailer – more important is having the right location.

After a difficult period, the group highlights there are signs the investment market has stabilised. In 2023, Tritax continued to crystalise value through asset sales and recycle capital into higher-returning development and investment opportunities. In 2023, £327m of disposals were completed at or above book value, delivering a blended Net Initial Yield of 4.3%, resulting in a £14.1m reduction in contracted rent. The aim is to sell £100m-£200m of further assets in 2024. The group acquired two urban logistics estates for £108m which provide potential for significant near-term rental reversion capture with a blended reversionary yield of 6.3%.

The market is seeing strong and diversified occupier demand, combined with historically low levels of availability, leading to rapid leasing of buildings and rental growth. Tritax’s portfolio vacancy edged up to 2.5%, although this includes one recent lease expiry undergoing refurbishment.

The group’s portfolio offers a secure, growing income – around a third of rent is generated by leases having an unexpired term of more than 15 years and 26% from leases expiring within five years of the period end and which provide near-term asset management opportunities.

The contracted annual rent roll increased by 0.6% to £225.3m, with increases from rent reviews, investment, and development activity, largely offset by disposals and a lease expiry. There was a 9.1% increase in passing rent across 22.5% of the portfolio subject to rent reviews. Tritax has delivered its tenth year of 100% rent collection. There was a 6.9% like-for-like growth in ERV (estimated rental value) in 2023 resulting in a record 23.0% portfolio reversion, of which the group believes it can capture 78% in three years.

Looking forward, there are good prospects for rental growth to exceed inflation over the medium term. Around 30% of the portfolio is subject to rent reviews in 2024. With a blend of inflation-linked (49%), open market (30%), fixed (9%), and hybrid (12%) review types, the group is well placed to capture attractive levels of accelerating rental growth.

The growing rental stream means the group can adopt a progressive dividend policy, with the intention to pay out more than 90% of adjusted earnings. For 2023, the group will pay a dividend up 4.3% to 7.3p (94% payout), amounting to a yield of 5% at the current share price.

On the development front, the group continued to make progress. £7.8m of annual contracted rent was added in 2023 through 0.9m sq ft of development lettings at a 6.7% yield on cost, with a further 0.9m in solicitors’ hands. There was 1.7m sq ft of development starts in 2023 with the potential to add £15.6m p.a. to contracted rent targeting a yield on cost of 7.0%. There group is maintaining its long-term development guidance of 2-3m sq ft per annum (£200m-£250m of capex) at a 6-8% yield on cost.

The group remains financially robust – the LTV stands at 31.6%, within the 30%-35% target range – with substantial covenant headroom. The current weighted average cost of debt is only 2.9%, with 96% of drawn debt either fixed or hedged, with an average maturity of 5.2 years. There are no debt facilities maturing before mid-2026.

The EPRA cost ratio fell from 15.7% to 13.1% driven by a 15.4% reduction in management fees and rental income growth.

Last month, the group announced it had reached agreement on the key terms of a possible all-share offer for UK Commercial Property REIT Limited.  The share price reaction at the time was negative. On the face of it, the rationale for a c. £800m deal looks weak – commercial property only accounts for 59% of the assets, with the rest made up of office, retail, and other space. There is no update today, with the company saying a further announcement will be made in due course.

Having recovered some of their poise in the second half of last year, the shares have slipped of late and currently trade on a 16% discount to EPRA Net Tangible Assets (NTA) per share, which fell 1.8% in 2023 to 177.15p.