Two of the UK’s largest listed real estate companies appeared to put the problems of the pandemic firmly in the rear view mirror this week – and are now hoping they have what it takes to handle bumps in the road ahead as the market faces its next big challenges.
Full-year results from British Land and Landsec continued a bullish earnings season for various parts of the real estate industry, after the big commercial agencies in the US posted bumper first-quarter figures over recent weeks.
At British Land, the bottom line was back in the black after an annual loss in the depths of the pandemic. The FTSE 100 REIT posted a profit of £960m for the year to 31 March, having lost almost £1.1bn a year earlier. The company made a total accounting return of 14.8%, driven by a 6.8% increase in its portfolio valuation to almost £10.5bn. Chief executive Simon Carter said the results showed “a strong performance” over the course of the year.
Fellow FTSE 100 heavyweight Landsec also turned around its loss from a year ago, moving from £1.4bn in the red to a profit of £875m for the year to 31 March. The total accounting return was back up to 10.5% after the previous year’s return of -15.9%.
Shareholders responded well – stock in both REITs was trading up following their respective results announcements. But neither British Land’s Carter nor Mark Allan, his counterpart at Landsec, glossed over the fresh macroeconomic and geopolitical factors that may now hit their businesses and the industry, including a cost-of-living crisis for consumers and the economic impact of the war in Ukraine.
Cost inflation
Rising build costs were an area of focus for both companies as they laid out plans for their development pipelines and did their best to assuage shareholders’ worries about the impact of inflation on their schemes.
Landsec’s Allan pegged construction cost inflation in the central London office market at about 6% over the past year industry-wide, and 3% for Landsec given its earlier moves to lock in costs with fixed contracts. Over the next 12 months, he said he expected the 6% figure to remain.
“What is really interesting at this point in time is seeing what’s going on within the supply chain and what’s driving that inflation,” he added in a presentation to analysts.
“Certainly energy costs – that is a big component of steel production… We have [also] seen squeezes on labour: I think there are 6% fewer construction sector jobs today than there were three years ago,” Allan added. “We are finding contractors are being a bit more conservative in their margins, so they are putting a little more in to cover their buying risk… but also being selective in terms of who they are choosing to work with, recognising that they would be potentially taking pricing risk within those contracts.”
As a “large-scale developer with a track record and a pipeline of further work”, Allan said, Landsec is in a “better than average position”. “But we can’t completely buck the trend of price rises on materials and squeezes on labour.”
Asked if contractors were increasingly unwilling to fix prices, Allan said he had seen no evidence in Landsec’s own dealings. “That is certainly not our experience at the moment,” he said. “It would not surprise me if there were elements of the market [where that was the case], perhaps with weaker contractors who were concerned about the risk to their balance sheet. We are working with tier-one contractors for whom that doesn’t apply. We continue to work and always would work very closely on an open-book, transparent basis to understand the supply chain pricing, so we would have real-time sight of that alongside a contractor as they are putting their contracts together.”
Maintaining momentum
At British Land, Carter said the company is forecasting 8-10% construction cost inflation this year, but has fixed 91% of the costs in its 1.7m sq ft committed development pipeline.
He added that British Land benefited from a decision to “keep the momentum” going in its development pipeline during the pandemic. Its strategy is underpinned by a £1.3bn urban logistics pipeline.
“We didn’t down tools on schemes, so we were able to get to contract before the worst elements of cost inflation came through,” he said. “We are doing that with great, tier-one contractors who we have long-standing relationships with. We don’t look to squeeze margins too much, it would be daft to do so – we want the contractors to be profitable and we want to deliver profits for our shareholders.”
Carter and colleagues now expect build cost inflation to “moderate but remain elevated” at 4-5% over the coming 18 months – helped by growing capacity in the construction market as some developers struggle to keep projects on track.
“We think raw material commodity prices will continue to increase, but at a slower rate, and then slightly offsetting that, we expect [to see some developers] struggling to move developments forward because of that cost inflation, because of their inability to get to contract,” Carter said. “So the development pipeline is getting pushed back and we think there will be more capacity in the construction industry in 12-18 months.”
Rental growth
If inflation continues to soar, the team is hopeful that rental growth will offset the worst.
“In the office market and urban logistics development, the best space in London is in really short supply,” Carter said. “If the development pipeline gets pushed back further, we think we can capture some good rents to offset any further cost inflation.
“One of the advantages of London development is that quite a lot of the cost is in the land. Only about 50% of total development cost is hard construction cost. So for every 5% higher build cost, you only need 2-3% extra on the rent.”
To send feedback, e-mail tim.burke@eg.co.uk or tweet @_tim_burke or @EGPropertyNews
