No. of Recommendations: 2
The discount to book value seems incredible now.
I am new to REITs and am beginning to see my mistake. I understood they had this really high occupancy rate of 97.5% from previous years (when the discount to NAV was 5%).
Then a couple of things begin to effect occupancy (government makes it less attractive for foreign students; cost of living forces more students to live at home, management buy Empiric, who have greater postgraduate exposure and are hit harder by the decline in foreign student demand.)
Management now guiding towards lower end of 93% to 96%, as they absorb Empiric’s 89% and three troubled markets in lower tier university cities (67%, 70% and 84%).
To a non experienced REIT investors like me, that doesn’t seem to justify such a brutal discount to book value. Then I begin to look at it closer and I realise that the difference between 97.5% and 93% goes directly to the bottom line, massively eating into profits.
The second factor is interest rates. Not only is Unite’s income coming under pressure, the ultra low interest rate loans they secured during Covid are maturing and are being refinanced at significantly higher rates. Management reports that the effective interest rate will continue to climb, even as U.K. base rates are falling.
Buying Empiric in this environment was a mistake. They could probably have bought it cheaper at a later date in hindsight. Regardless of how it works out long term, the stock market is calling this out as poor management judgment. Management judgement is important in this game presumably.
The question now - are the factors that are weighing on occupancy rates, structural or cyclical? If they are structural, management and the student housing market will adapt by limiting supply. This is already happening with fewer units being built. Unite have strategically shifted: selling properties, cancelling developments, concentrating on the higher tariff cities that have high occupancy. They are buying back stock. That all sounds like a good idea if they can get reasonable prices for the properties they want to sell.
The rising interest rate challenge is likely more of a cyclical issue as base rates are falling.
The remaining question in my mind and I don’t know how to answer it is - what is an appropriate price to book ratio for a REIT experiencing these challenges? Surely not 0.53x?
Having demonstrated to myself that I know nothing about REITs and how they behave under different conditions, including changes in interest rates, I am not confident in my intuition that an investment in Unite is an incredible bargain but I shall continue to hold and hope operating conditions improve and the current situation is the eye of the storm.
