Analysis of Real Estate Firms in the UK - Case Study Example

ANALYSIS OF REAL E FIRMS IN UK 0- INTRODUCTION Prime objective of investment is return and investors are inclined to invest in the avenues ensuring two basic benefits; first, safety of invested amount and second being an attractive return (Gitman, 2003). Investment in real estate managed to capture attention of investors with recent highs and lows in equity market such recent global financial crises that wiped $7 trillion globally from stock markets (Havard, 2004). Furthermore, the physical existence characteristics of real estate envisage recovery in value even in case of decline in price. These and other characteristics of land has attracted individual investors to invest in real estate sector; sector that was initially dominated by institutional investors. Hence, currently real estate market has a combination of investor direct, indirect, individual, local, overseas and institutional investors with investment in residential as well commercial market (IPF, 2007). Alike all investment classes real estate investment has business phases where if in one phase of real estate investors reap sizable return then there are all chances similar investment may not fetch investor attractive return due to economic and market condition that impact the real estate sector (IPF, 2007) (IPF, 2007) The property cycle as presented is affected by varied quantum of risk such as political, regulatory, economic, property, market, sector, product, tax etc (IPF, 2007). Inability to address these factors even in booming real estate sector conditions can lead to losses; in contrast to this, carefully addressed factors in down turn can mitigate the impact of the huge risks. With growing number of investors, attention to assess the real estate market has also increased. The assessment usually encompasses the past performances by developing lessons for future investment, investors’ performance analysis; future prospect as well recommendation to safeguard investment from losses. The report here in follows the same format with following sections: Section I- Introduction to real estate market Section II- Overview of credit crises Section III-Companies sustenance in credit crises Section IV-performance analysis of two UK real estate companies for year 2012-2011. Section V- Recommendation for investment in real estate sector Section VI-concluding note for the assessment 2.0- COMMENT ON CREDIT CRISES The credit crunch that hit to US in autumn 2007 was considered less relevant to UK and other European markets despite the fact of evident impact these market were sure to receive due to diversification (Adair, Berry, Haran, Lloyd, and McGreal, 2009). An effort of Bank of England on the linkage and its leading impact went unnoticed unless crises landed to UK door step (Bourke, 2007). Prior to financial crises, UK property market witnessed boom for 11 to 13 year after decline in 1999; Nationwide and Halifax, two indexes reported. (Adair, Berry, Haran, Lloyd, and McGreal, 2009) Similar to housing property market boom; commercial property market has also gained momentum fetching attractive returns for the investors. For instance, real estate investment in commercial property market has remained the most attractive one with strong total return of 20.2% since 1999 decline. Further, the attraction accelerated in the time spam of 1992-2006 with standard deviation of 6.1% in comparison with 15.8% of equities (Adair, Berry, Haran, Lloyd, and McGreal, 2009). (Adair, Berry, Haran, Lloyd, and McGreal, 2009) This growth includes the investment from local as well as overseas investors to invest; factor that brought to inland of UK impact of financial crises (Adair, Berry, Haran, Lloyd, and McGreal, 2009). Only commercial property investment accounted £81.1 billion from newly approved loans in 2006 while over all lending for investment in stated segment has counted to £172.1 billion. On the other hand, in residential sector impact of global financial crises has combined with over capacity investment that has resulted in sizable outflows from UK real estate market. Among major outflows include £129 million of investment from Irish investors withdrawn in 2008 (Capital Economics, 2007). Liquidity financial crises combined with capital outflow and deteriorated investors’ confidence on financial markets has multiplied the impact with lending institutions tightening policies; outflow leading to decline on return putting pressure on institutional investors and finally investors holding empty property for ignoring consistent and robust income stream from tenants. In the light of above facts, it can be confidently stated that impact of financial crises has increased its magnitude not only for the crises itself but for many reasons with dominant reason being excessive lending even at the cost of the necessary requirement compromised. Hence, as the crises hit and market headed to correction bubbled portion of sector investment could not sustain and collapsed. This also hold important lessons for investors to invest in sound options with meeting necessary requirements as market always move to correction sooner or later. 3.0- COMPANIES SUSTENANCE IN ECONOMIC DOWNTURN UK’s property market as estimated in year 2007 was accounted £760 billion worth with major component occupied with offices, retail and industrial property along with limited contribution section for leisure, residential (including student accommodation) and health-care related properties (British Land Company, 2012). After severe down-turn shock to UK property market, recovery was witnessed in last two years. Furthermore, London has remained the dominant real estate performer with respect turnover (by value) of investment properties in 2010 (Deloitte, 2012). Capital value for investment property has declined considerably and companies as followed the following trend from rise to decline then back to recovery: (British Land Company, 2012) Hence, companies with strengthened portfolio with rental income component have managed to sustain. Further, after the financial crises hit survival breathes came from UK government’s injection in 2008 almost an amount of £37 billion into the British banking system. Injection initially is aimed to support banking system along with later (second) phase to stimulate lending (Adair, Berry, Haran, Lloyd, and McGreal, 2009). By the time, government efforts started to pay-off firms with reliance on capital income only had already generated considerable loss. Moreover, secondary trading of investments, a sizable component of which can be attributed to speculative trading declined greatly and genuine primary investors remained in market as visible from graph above. 4.0- PERFORMANCE COMPARISON OF COMPANIES For the performance assessment of the real estate sector of UK, analysis of two real estate firms have been conducted for the two recent years i.e. 2012 and 2011. Companies picked for assessment include The British Land Company Plc and Sirius Real Estate Limited. Selection has been done on random basis and given below is the ratio analysis with respect to companies’ performance, efficiency and solvency position.   RATIOS INDICATORS The British Land Company PLC Sirius Real Estate Limited     2012 2011 2012 2011 1 PERFORMANCE RATIOS Indicates performance of company 1.1 Prime Ratio Profit generated from capital employed 7.55% 14.12% -3.35% 3.15%   (PBIT / CAPITAL EMPLOYED)         1.2 Profit Margin Ratio Profit Margin on sales 176% 313% -21% 35%   (PBIT / Turnover)   1.3 Capital Turnover Ratio Generation of sales with Capital employed 0.043 0.045 0.159 0.090   (turnover/ Capital Employed)   2 SOLVENCY RATIOS Capacity of firm to pay off current liabilities     2.1 CURRENT RATIO Liquidity to pay current Liability with current asset 1.299 0.541 0.127 0.893   (Current Asset / Current Liab.) 2.2 ACID TEST RATIO Liquidity of firm excluding impact of inventory 1.188 0.541 0.086 0.893   (current Assets- inventory)/ C.L) 2.3 DEBT COLLECTION PERIOD Days firm requires to recover money from debtors 184.699 110.235 77.428 58.249   (365/(Turnover / Debtors)   3 Investment Ratios Efficiency of utilising investment     3.1 Return on Capital Employed (Prime Ratio) Efficiency of utilising invested capital 7.55% 14.12% -3.35% 3.15%   (PBIT/ Capital Employed) 3.2 Return on Equity Efficiency of utilising invested equity 9.38% 16.84% -17.16% 1.64%   Profit before Tax/ share holders equity) Overall performances for the two firms have showed that decline in performance in year 2012 as compare to the 2011. The decline of much larger magnitude that pushed back the Sirius Real Estate Limited in the negative domain while the The British Land Company Plc performance has declined by near to half. Sirius Real Estate Limited (SREL) has maintained lower profit margin and, therefore, as the jolt hit the market SREL has moved to negative domain. Similarly, the profit margin of three hundred percent fell near to half for The British Land Company Plc (BLCP). However, despite negative results overall, capital turnover ratio has presented healthy picture of performance of SREL as the firm has employed strategy to utilise the capital in the most efficient manner to generate revenue. Whereas BLCP instead of positive financial results lacks far behind in efficiency of capital utilisation on this front and positive results can be attributed mainly to high profit margin specifically. Solvency is one of the most important factors of any business when two companies are being analysed; where the sector is self famous for being less liquid investment avenue as compare to other investment option. Moreover, it is also for the same reason that individual investors have been greatly reluctant to adopt this investment option in portfolio. Solvency situation of two companies present much mix results; making it difficult to infer the trend for both companies with respect to market conditions. Current ratio for SREL has declined for the year 2012 while BLCP has improved greatly in 2012 as compare to critical condition it had in year 2011. Moreover, both firms had no tradable investment in property intended to be traded with short term. SREL has tight credit policy as compare to BLCP. There exists difference of almost double in the credit policy of both firms. This difference cannot only be attributed to credit policy; in-fact, the difference may also be for the fact of differences in portfolio components. This inference is also supported by the statistics of profit margin where BLCP is able to fetch the profit of multiple times as compare to SREL. Therefore, BLCP has to increase the length of recovery period from debtors in critical trading areas as compare to SREL. Overall return on investment is also measured to assess the performance of the firm with respect to generating return from invested capital. Since both firms are public; therefore, performance is assessed on overall return on capital employed that includes equity as well as long term debt and return with respect to equity only. Impact of almost half is witnessed in return generated from capital employed as well as return from equity only. BLCP has less long term debt in its capital structure; therefore, more profit is attributed to public as compare to overall capital employed. In contrast to this, SREL seems to have high long term debt in capital structure. In addition to this, SREL high debt put serious set-set back in jolt time of 2012 that reduced overall performance of the firms and left equity investors to with losses. Hence, SREL must require addressing this capital structure weakness. Overall assessment reflects both firms differ in size, portfolio as well as capital structure and hence, variance in performance is witnessed. Moreover, BLCP is comparatively sound firm as compare to SREL that managed to sustain its performance in the difficult year of 2012. It also appears from the performance that BLCP is larger company on scale whereas the SREL is trading at smaller scale. The strategy of BLCP to charge high profits reflects its understanding to fetch sizeable return from every deal as nature of business demands as compare to SREL that charges considerably less return and hence, is not capable to sustain in case of crises. Moreover, extra length of time or high average receivable periods is good strategy of BLCP as far as it is supporting firm in getting business activity and remains sustainable. In contrast to this, despite SREL manages to receive payments earlier but the strict strategy is not contributing in main purpose of business; hence, is not worth for. SREL also requires adjusting its capital structure that reduces the burden of interest expense on the firm and allows firm to distribute less or no income to distribute equity holders in case firm doesn’t have sizeable or any returns. 5.0- RECOMMENDATIONS Recovery is the next step to come after every decline and real estate investment has witnessed the greater boom after every decline. Therefore, business shall harness their belts to take the benefit of the next boom. However, the condition to invest with factors having impact must be accounted in detail. Given below are highlights for the expected performance of real estate sector that shall be taken as guideline to undergo investment: Overall performance for the next two years of all segments of real estate has positive outlook as given below: (Colliers, 2012) However, the outlook has been trimmed accounting for the debt issue of US that still poses great deal of uncertainty. Return from investment in all sectors has been downgraded from 8.8% to 6.7%. However, Q4 2012 transactions have gained an upward trend with £4.5bn of 170 transactions (33.2% up from last year’s same quarter) while overseas investors taking up more than 60% share; hence, highlighting the confidence recovery of local as well as international investor (6). Among all sectors, retail will continue to underperform mainly for internet retailing boom. Declining number of stores will continue with the boom. Last quarter of 2012 witnessed sizable deals in the retail sector. Moreover, all deals conducted for the retail sector outside London; giving positive signal for investor. However, the sector will manage to gain back performance in the positive direction in 2013 as compared to year 2012. Despite positive GDP forecast and lower inflation, decline in rental income will be witnessed in 2013 due to internet boom (6) Investment ion offices will continue especially with insurance sector setting up offices. Office investment especially in the new spaces under construction is likely to have negative impact on the rental and estimation for rental income for 2013 has been downgraded from 4-5% t0 3-4%. Moreover, offices outside London will see further contract (6). However. London will continue to take dominant position in world trading cities for the reason of providing safety, security as well as connectivity to the businesses. As soon the global economic recovery gains momentum expectedly by second half of 2013, UK especially London rentals will also accelerate in positive direction. For the third segment of industrial despite increase in deals and value of deal in final quarter of 2012 by 22.9% as compare to same period of 2011; the risk aversion of investors in London will retain the rentals flat over 2013. Investment in industrial sector is taken as way to diversify portfolio. On the basis of above forecast for the year 2013, investors shall continue to select investment option suiting to their capacity as well as risk return requirement. For instance, investment in areas apart from London that is fetching investment; facilitating investment packages that attract overseas investors are important points for individual as well as institutional investors. Moreover, despite decline in forecast of rentals income, it shall constitute component of invested amount as it ensure stable stream of income in case capital growth is held. 6.0- CONCLUSION Investment in real estate gained attraction for investor upon the fluctuation of equity market, Investors are attracted to this investment option for many reason such as consistent rental income etc. However, analysis of history marks that speculative investment in this domain like others also have resulted in collapse. Further assessment of companies highlighted importance of various aspects to be considered in order to retain sustenance in performance. The report in the developed recommendations for the investors in the light of future forecast for the UK real estate investment market. The forecast reflects the positive signs of recovery for the sector with retail and rental still resistant to gain momentum. Hence, investors must assess and align their respective capacity to market conditions to ensure positive and sustained performance. References Adair, A., Berry, J., Haran, M., Lloyd, G., and McGreal, S. (2009). ‘The Global Financial Crisis: Impact on Property Markets in the UK and Ireland’. University of Ulster Real Estate Initiative, Available from http://news.ulster.ac.uk/podcasts/ReiGlobalCrisis.pdf [Accessed 15 January 2013] Bourke, C. (2007). Feeling the Pinch. Estates Gazette. British Land Company. (2011). Annual Report. Available from http://files.the-group.net/library/britishland/files/pdf_200.pdf [Accessed 15 January 2013] British Land Company. (2012). Annual Report. Available from http://www.britishland.com/files/reports/2012_annual_report.pdf [Accessed 15 January 2013] Capital Economics (2007). UK Commercial Property Market Monthly. Colliers. (2012). Reif In Brief Q4 12: Real Estate Investment Forecasts. Available from http://www.colliers.com/en-GB/uk/~/media/Files/EMEA/UK/research/investment/201212-real-estate-investment-forecasts-brief.ashx [Accessed 15 January 2013] Deloitte. (2012). Real Estate Predictions 2012: New Realities, new perspectives. Available from http://www.deloitte.com/assets/Dcom-Austria/Local%20Assets/Documents/Studien/uk-re-real-estate-predictions-2012.pdf [Accessed 15 January 2013] Gitman, L. (2003). Principles of Managerial Finance. Boston: Addison-Wesley Publishing. Havard, T. (2004). Investment Property Valuation Today. London, Estates Gazette. IPF. (2007). Understanding commercial property investment. Available from http://www.bpf.org.uk/en/files/reita/reita_org_documents/reita_guides_ifa_guide_May07.pdf [Accessed 15 January 2013] Sirius Real Estate Limited. (2011). Annual Report. Available from http://www.sirius-real-estate.com/media/pdf/Sirius%20Real%20Estate%20Limited%20Annual%20Report%20and%20Accounts%202011.pdf [Accessed 15 January 2013] Sirius Real Estate Limited. (2012). Annual Report. Available from http://www.sirius-real-estate.com/media/pdf/Sirius%20Real%20Estate%20Limited%20Annual%20Report%20and%20Accounts%202012.pdf [Accessed 15 January 2013] Read More