Jefferies downgrades Big Yellow and PRS in REIT sector review

The broker said it was cutting its price targets across the sector by an average 7%, as REITs' cost of capital has risen from 8.1% to 10% so far this year, while real estate returns are just 3% year-on-year, with growth in retail and industrial assets weighed down by declines in the offices sector.

"We expect discounts to book to persist as equity markets risk adjust backward-looking NAVs. REITs are under the ‘macroscope’, with valuations externally set by the macro more than internally by rents," the broker said.

The broker said it is now favouring EBITDA valuation ratios in its stock selection as net asset value metrics have become "unreliable with the slump in investment trade".

As such, Big Yellow Group has been cut from 'buy' to 'hold', with its target price falling to 1,224p from 1,359p, while PRS Reit was also reduced to 'hold', with a new target of 110p down from 120p.

Landsec has been lifted to 'hold' from 'underperform' (target changed to 525p from 515p), Hammerson was kept at 'underperform' (target moved to 180p from 150p), while Great Portland Estates was maintained at a 'hold' (target cut to 300p from 313p).

As for the outlook for the sector, Jefferies said that rental growth at a time of low economic growth and high government borrowing – particularly after the autumn budget – looks "muted".

"REITs need M&A in an over-crowded sector to reduce management costs in a SloMo cycle making scale a virtue, but, in an island economy with tight zoning rules, portfolio specialisation is a constraint."