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Land Securities vulnerable to a fall in London office demand



Global stocks traded at highs for the year, as better than expected US data, well-received corporate earnings, takeover activity and hopes for continued central bank support help drive sentiment.

The S&P 500 hit a record peak after well received results from banks and technology companies, while the FTSE 100 reached its highest level since last summer, propelled by Softbank’s £24.3 billion bid for ARM Holdings.

Recent risk events, such as Brexit and the failed coup attempt in Turkey, have largely been absorbed by markets because they reinforce the preferred trend of interest rates staying lower for longer. The Bank of England, Bank of Japan and the European Central Bank are widely expected to loosen policy further at their next meetings.

Yet, as the US economy powers on and investors look ahead, the theme of divergent monetary policy between the US and the rest of the world is beginning to resurface. A surprise acceleration in US job growth, stronger retail sales and improved house building activity point to a optimistic US consumer, prompting expectations that the Fed may be coaxed into raising interest rates later this year.

Two weeks ago the futures market were pricing in an 8% chance that the Fed would raise rates by 25 basis points in December, but the probability climbed to 46% this week. The dollar index, which measures the reserve currency against a basket of its major peers, reached a fresh four-month peak.

The firmer dollar weighed on industrial commodities, hurting mining and energy stocks and pushing base metals lower. Despite events in Turkey, which occupies an important position in oil routes, Brent crude drifted back towards $46 a barrel, its lowest level for three months.

Technical analysis of the FTSE 100 suggests the post-Brexit rally could be running out of steam. Despite a strong week for global stocks, the blue-chip index has barely moved in the past 10 days, while the bearish divergence evident from the fading oscillators suggests momentum is wilting. The MACD histogram has slipped into negative territory and the stochastic is back at its lowest since the underlying index was last below 6,000, so I believe some consolidation is necessary and support is seen at 6435 and 6280.

In conclusion, the crutch of central banks has reinforced the argument for equities as an asset class, as cash is yielding close to zero and real bond yields are far below normal levels. That said, I don’t share the rose-tinted spectacles investors have adopted over the future of interest rates and I believe a realisation that central banks may not ease further, may trigger some profit taking after the recent gains.

The US stock market is at an all-time high, economic data is strong and corporate earnings have largely beaten expectations, so there is a real chance that the Fed may hike again this year. Meanwhile, I question whether the Bank of England is really going to cut rates further from 0.5% without knowing what future impact Brexit may have on the economy and while uncertainty is high, it may not even have the desired impact a cut in rates is designed for. 

Property is a cyclical asset class, driven by sentiment from businesses and consumers, hence due to the uncertainty since the referendum, property companies have been hardest hit and recent data already indicates that market activity has slowed. The Royal Institute of Chartered Surveyors reported that buyer enquiries fell sharply in June, while they expect house prices will fall across the country in the next three months.

At present “passporting” rules allow financial services firms to operate in other EU countries from a UK base, hence London has often been dubbed the financial centre of the world, yet it is unclear whether these rules will remain in place if the UK leaves the EU. Britain is home to around three quarters of all cross-border investments firms licensed across the entire EU.

The remaining 26 EU countries are likely to only allow Britain to maintain passporting rights if it also allows free movement of people, something those in favour of leaving have sought to control, so leaving the European Union could mean some firms, particularly those in the financial sector, choose to relocate staff.

A recent survey of more than 100 top financial services firms that use passporting found that 57% said they could be forced to relocate staff if the rules change and 56% of those have already begun looking at options for moving part of their business to a different EU base.

This could have a huge detrimental impact on commercial property in London and chief executive of Land Securities (Epic: LAND), the largest Real Estate Investment Trust in the UK, warned this week of subdued demand for commercial property and the potential for a drop in rents.

Land Securities own, develop and manage offices, shopping centres and retail parks in the UK, yet over a third of its 17 million square foot office and retail accommodation is in London, including 20 Fenchurch Street, known as the Walkie Talkie and the new “Zigzag” building in Victoria.

The London-based commercial property firm also has 500,000 square foot in its development pipeline in London, which is yet to have a tenant secured and owns a further 2,800 acres of strategic land across the capital ripe for regeneration.

As of the end of March 2016 the vacancy rate in London offices was just 2.6%, compared with the long-term average of 4.3%, yet CEO Rob Noel warned that “we expect business uncertainty to persist until there is more clarity on both the timing and terms of the UK’s exit from the EU. Meanwhile, demand from occupiers is likely to be subdued until confidence returns and this may have an impact on rental values.”

Land Securities has proposed a 9.9% increase in its total dividend for the year, taking it to a 3.4% yield, yet the company trades on 24x earnings and profits are now expected to fall next year and beyond that the outlook is uncertain.

The chart of Land Securities illustrates the roller coaster ride since the EU referendum, with an initial 25% decline swiftly followed by a 20% recovery. Yet the moving averages are trending lower and resistance is likely to come from the 50-day at 1100p and the 200-day at 1135p, while the subdued oscillators suggest momentum remains subdued.

Capital values for property assets have risen 45% since 2009, but are now widely expected to fall this year, weighing on the net asset value of Land Securities, while a drop in rents is expected to reduce profits, leaving the high valuation looking stretched.

At the time of writing the share price is 1087p, which I believe offers shareholders a good opportunity to exit positions. Traders may also consider short-selling the shares with a tight stop-loss above the moving averages at 1141p, with near-term targets seen at 1022p, 957p and 910p.

This report was written by Michael Allen, equity specialist. The writer does not hold a position in Land Securities. The material in this report has come from web-based data sources and Land Securities’ corporate website.





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