Initiating on Derwent London (OW) and assuming
coverage of Great Portland (OW). Fundamental
signposts for a trough in UK commercial property are
appearing, but UK property stocks are trading at record
premiums to spot NAV and already price in a substantial
positive bounce in values, as at previous cycle troughs.
Nevertheless, longer-term investors should favour the
West End office stocks to the UK property majors, in our
view: they offer the highest exposure to cyclical London
offices, and a far bigger development pipeline.
Near-term, lower gearing should protect the shares from
a pullback in value, while smaller size should provide
nimbleness to exploit market inflection points.
Prefer offices to shopping centres. London offices
have historically been more cyclical than shopping
centres and performed better from troughs in the rental
cycle. Headline City office rents look close to troughing.
whereas prime West End still risks some downside – but
we think the West End plays still provide the best
exposure overall to the London office segment.
Prefer development to investment. The gap between
property values and construction prices is at a 40-year
low, so pure development schemes are likely to remain
limited for now. That said, although pipelines remain
light, both companies have a string of medium-term
opportunities that should come on-stream as
construction prices fall.
Prefer Great Portland to Derwent. Derwent and Great
Portland differ primarily on capital raising strategy and
financial leverage; the former raises capital piecemeal
with acquisitions, but Great Portland’s May rights issue
leaves it with £400-500m headroom to invest and an
LTV ratio of 30%. Our cautious view on property shares
makes Great Portland our preferred short-term pick;
more bullish investors should choose Derwent, we think.