Real estate share prices drop: How will the pain ease?
By Jenal Mehta
Updated
Rising interest rates are likely to slow down the housing market, leaving revenue streams dry for real estate investors. However as inflation cools, the sector is likely to pick up, making stocks worth watching right now.
Real estate development came to a screeching halt at the start of the pandemic, when labour shortages slowed down construction and made supply chains more complicated. For real estate equity investors, this resulted in dividend incomes reducing substantially.
Invesco (IVZ), Hammerson (HMSO), and Landsec (LANDI) cut their dividend payments during this time.
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Invesco (IVZ) Price Chart
Hammerson (HMSO)
Eventually this should lead to a reduction in inflation, which will see the sector recover. For now, analysts say that the situation will get worse before it gets better, potentially providing shorting opportunities for the keen investor.
Landsec (LANDI)
Just as dividend pay-outs are recovering, they face a period of high interest rates. This will reduce the level of funding available in the industry to develop properties, hindering revenue streams.
This situation places an upward demand on rental properties, allowing real estate companies to sustain a certain level of income, albeit lower than it would be at non-inflationary times.
Rising costs
Labour shortages due to lockdown restriction meant that construction was halted most of 2020 and 2021. Furthermore, this also impacted supply chains, breaking down the normal access companies would have had to materials.
While some firms like Great Portland Estates (GPORgb), Big Yellow (BYG), and Land Securities (BLND) where able to sustain a relatively stable level of dividend pay-out during the pandemic, Invesco (IVZ) and Landsec (LANDI) cut their dividend payments in half at this time, while Hammerson (HMSO) dropped its dividend per share from 14.8 pence per share to 0.2 pence.
Laith Khalaf, head of investment analysis at AJ Bells told Capital.com that although we can expect a reduction in the level of pay-out during a downturn, “many of the FTSE 350 housebuilders are offering attractive dividend yields, which are generally well-covered”.
Land Securities (BLND) Price Chart
Rising interest rates
When inflation is a threat in an economy, central banks generally increase interest rates to discourage borrowing and this slows down the economy, which over a period of time should reduce inflation.
Currently, both UK and US economies see multi-year high inflation rates and both the Federal Reserve and Bank of England are set to increase interest rates throughout 2022.
For real estate sector this means that loans are now more expensive, making new construction difficult, while retail sales also plumet as house buyers would be reluctant to pay higher mortgage rates. This will result in the sector seeing a reduction in earnings for the coming period.
As Khalaf puts it: “Interest rates and a slowing economy represent headwinds for housebuilders, but the sector is generally sitting on quite a low valuation, which means a lot of pain is in the price.”
Nancy Vanden Houten, lead US Economist at Oxford Economics said in an investor note that house sales have fallen for a fourth consecutive quarter in May. She adds: “Looking ahead, we expect existing home sales to lose more momentum as a sharp erosion in homebuying affordability weighs on sales. Resilient demand – including from investors – and strong income gains may keep home sales from plummeting too sharply if home price growth moderates”
Rental income
As investors and house buyers both turn away from taking out loans, they instead turn to renting properties, waiting to buy once interest rates drop. This means that companies with large portfolios of rental properties, can sustain a healthy level of income and dividend pay-out.
For these companies rental income, rather than capital appreciation, would be a key driver of performance.
Outlook
Evidently the outlook on the sector is highly dependent on the economic cycle. For the moment, house prices continue to rise, keeping prices tight according to Savills.
A real estate outlook for 2022 by PwC states that it is challenging to predict the direction of real estate at the moment, as this downturn is quite unique. They point out a potential risk in the sector: “A key difference this time is that industry may also have to deal with the consequences of very swift changes in government spending in favour of defence and energy policies and away from the areas that directly affect real estate, such as infrastructure and housing.”
Khalaf believes that for now: “It’s probably a decent area to go fishing for value-hunters, but as ever this strategy requires investors to accept things may get worse before they get better."
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